First few days into December, it’s always a good idea to check your finances before going crazy at the mall. When I got my November investment statements, I was a little disappointed to see it wasn’t the greatest month on record. But, it wasn’t all that bad either because I stuck to a few simple rules I preached to others during my broker days.
My first and only rule is asset diversification. Getting more specific, I make it a habit never to have more than a quarter of my investments in a single sector. Most of the sectors I felt attached to were sort of acquired tastes, biotechnology, nanotechnology, etc. But, regardless how attracted I might have been, like many investors, I learned this lesson the hard way when the tech bubble burst. So, this time around, 25% in a particular sector was the absolute maximum I would ever go for.
I also make sure when diversifying, to cover as many asset classes and sectors as possible, investing between five and ten percent into each. The reason why is simple. Market sectors are cyclical beasts. The good thing about them is that while one or more sectors could be going through a down cycle, their losses could easily be offset by sectors going through an up cycle. That’s the true beauty of diversifying.
Finally, ten percent investment in a single stock is the absolute ceiling beyond which I’m not ready to go. Even if the stock is performing well and its market price pushes that weighted percentage above ten percent, I see this as a sign to sell, pocket the profits, and trim the exposure back to ten percent or less. Again, this is one more lesson learned the hard way when I let Nortel Networks rule my world a few years ago.
Why is it important to apply these rules? Well, history is truly a great teacher. The switches between bear and bull markets have had the most influence on long-term returns. For example, in the past two decades, the bull market has peaked twice: the first time in 1987 and the second time in 2000. Both of these peaks have been followed by spectacular crashes, leaving some sectors under water for quite a few years. Also, historically speaking, these crashes were best offset in individual portfolios by proper asset and sector diversification.
So, before you let your credit and debit cards to reach to point of meltdown in the mall this holiday season, talk to your broker about diversifying your portfolio. Take my word for it; come January, you’ll be glad you did it.