Portfolio diversification is the smartest investment option



Diversification is your ally when it comes to developing an investment portfolio.
Diversification is your ally when it comes to developing an investment portfolio.

Owning individual stocks can be a silly investment strategy. In mid-August the Samsung Galaxy Note 7 went on sale. Five days later the first phone exploded. In September, Samsung recalled 2.5 million Note 7s because of faulty batteries.

A few weeks later the replacement phones started to catch fire. In early October a Note 7 phone onboard a US airliner caught fire and the airplane had to be evacuated.

On October 11, Samsung stock lost $20 billion (U.S.) in value during one day.

This is one of the most significant technological and public relations challenges we have seen — that is a risk senior management of Samsung will have to address.

This type of risk is something that every investor should address. As stated above, owning individual stocks can be a silly investment strategy.

Diversification is your ally when it comes to developing an investment portfolio. Putting too many eggs in one basket can backfire.

My recommendation is to invest in the overall stock market, not just a few individual stocks. When one specific company runs into trouble it does not have any significant impact on your portfolio value.

Some argue against the diversification approach, saying that certain companies are safe and a portfolio of say 10 different safe stocks is all the diversification they need.

Under the definition of safe, Samsung would qualify as a safe stock. One third of all smarts phones sold in Canada during the first half of 2016 were Samsung. Consumers trust Samsung and four million had purchased the Note 7 phone worldwide.

Samsung is a world-wide technological giant. It has been a trusted firm.

There are many examples of strong companies that experience woes.

Nortel is the best example in Canada, and in the U.S., several very strong old established financial institutions went out of business during the recession of 2008.

Risk does happen and the best investment portfolio anticipates risk and plans ahead.

When any seemingly safe stock loses significant value there are many who own that stock who are hurt. Many people gravitate to holding stocks they are familiar with and understand.

Familiarity is not an adequate line of defense. Bad stuff does happen even to what you perceive as safe.

You might be familiar with the popular notion in financial planning: all market corrections have successfully recovered and market values have gone on to reach new highs every time.

This logic is used to support taking a long-term investment approach.

That only applies to very well diversified investment portfolios. When you invest in just a few individual stocks it is “caveat emptor,” which stands for buyer beware.

Re-examine your own investment strategy and to see if you could benefit from increasing the amount of diversification in your investment portfolio.