A truly diversified portfolio contains securities that zig when other securities zag. That means owning stocks, bonds, or mutual funds that do not react in the same way to a given economic environment. For example, many investors make the mistake of buying a portfolio of recently top performing funds. What they can wind up with is an undiversified portfolio. Since the top funds the investor purchase may have many of the same kinds of securities or attributes. If the investment climate changes for those securities, big losses may be the result.
To determine whether you are truly diversified look at the stocks, bonds, and mutual funds you own.
- Are they concentrated in a few industries?
- Do they have similar characteristics? For example bonds and utility stocks behave alike.
- Do you own too much of a single country’s securities? Is more than 3% of the portfolio invested in any single security?
Extremely good and bad portfolio performance can often be traced to a poorly diversified portfolio.