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A Diversified Portfolio
You can build shock absorbers into your stock investments
to cushion a bumpy ride.
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The stock market
as a whole moves up or down in value from time to time — a phenomenon
called a market cycle. Sometimes the turnaround is predictable,
and reflects economic or political events in a country or in the world.
But sometimes the market changes directions for reasons that aren’t
so clear. There’s no hard and fast rule about when or how often these
changes will occur, and no foolproof way to predict what will happen. |
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CYCLICAL
vs. COUNTERCYCLICAL
Some stocks tend to rise and fall with market
cycles because they're more sensitive to changes in the economy than
others. Called cyclicals, these companies operate in industries
that flourish in good times. Typical cyclicals are airline or automobile
companies or companies selling leisure-time products and services.
Owning a cyclical stock can be a good investment, especially if you own
it at the beginning of a bull market, when prices in general tend to head up. But if you own only cyclical stocks,
the value of your overall investment portfolio may stall or shrink when
the economy slows down.
Other stocks, sometimes called countercyclicals, tend to be more price-stable
in good times and bad. Typical countercyclicals are companies that provide
necessities, such as food, electricity, gas, and health care. Owning countercyclicals
can help protect you in a bear market, when prices in general head down. But if you own only price-stable
stocks, you risk missing an opportunity to profit when cyclicals generally start rising again.
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SPREAD THE WEALTHAny time you concentrate your money in one place, your
financial security depends on the strength of that investment. So a
portfolio that’s concentrated in one market sector, or only in cyclicals,
is in danger of losing value if that sector weakens, or the economy falters.
One way to protect your stock portfolio is to diversify your holdings.
Using a diversification strategy, for example, you would buy stock in some cyclical
and some countercyclical companies, in some large companies and in some
small ones, in some new industries and in some older, more established
ones.
With a diversified portfolio, your investments are cushioned when the
market hits bumpy times. That’s because when you own stock in several
different categories of companies — and as your portfolio grows, in
a number of different companies within each category — the chances
are that when some stocks lose value, others will gain.
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 VOLATILITYAnother way to diversify your portfolio
is by balancing volatility and stability.
Volatile stocks—such as small company and new company stocks—sometimes
climb steeply, but may also lose value quickly. A portfolio made up primarily
of small-cap stocks will tend to be volatile even if the companies are
in very different industries.
Big companies are generally more price stable—another way of saying
less volatile—than small companies. They have established track records,
greater financial reserves, and experienced management. However, that
doesn’t mean they can’t lose value or underperform in some markets.
SIZE MATTERSOne important way to diversify is by spreading your
investments across small, mid-sized, and large companies. A company’s
size is determined by its market capitalization, which is computed
by multiplying the number of existing shares by the current price per
share. For example, a company with 100 million existing shares worth $25
a share would have a market cap of $2.5 billion.
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© 2006 by Lightbulb Press, Inc.
All Rights Reserved.
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