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FOOL GLOBAL WIRE Hoffman Estates, IL (Mar. 20, 1997) -- One of the teens in the teen message folder asked me a question that indicated to me that there is some confusion surrounding the concept of diversification. Somehow the idea of dollars versus shares has worked its way into the definition, which I believe is where the confusion originated. Since he was referring to the Fool 4 portfolio, I thought I'd answer his question here with a discussion on diversification. When the Dow Dividend Approach was conceived, one premise behind it was simplicity. In the interest of simplicity, we recommend equal dollar amounts be used in the investment process rather than equal share amounts. With equal dollar amounts from the start, keeping track of the monetary gain or loss for the entire portfolio, as well as among the individual stocks, becomes much easier. Since each stock begins with the same amount of money, the percentage of gains and losses are more easily calculated when the stock prices fluctuate (since share prices are given in dollar increments as well). But this really has nothing to do with diversification. When we speak of maintaining a diversified portfolio, we're referring to the type of stocks you hold. Different companies fall into different sectors, and can be further broken down into different industries. For instance, the technology sector contains stocks related to all forms of technology, including computers, medical technology, and communications stocks. From here it can be broken down even further. In the computer area there's computer hardware, computer software, computer services, online and web-related services, etc. With in mind, let's take a look at the Fool 4 portfolio. Due to the way we choose the stocks, true diversification may not always be achieved. This year we happened to luck out in that the four stocks are from widely divergent sectors. These stocks and their sectors and industries are as follows: Sector Industry
AT&T Services Com. Serv.
CHEVRON Energy Oil/Gas - Integrated
GENERAL MOTORS Consumer Auto & Truck Man.'g
Cyclical
MINNESOTA MINING Capital Goods Cons. - Supplies
& MANUFACTURING
As you can see, no two are in the same sector or industry. This is true diversification. Why do Fools recommend that you diversify? Just think about what happens when news comes out affecting one specific sector or industry. Last year there were several months of negative news articles stating that retail sales were down, causing a reduction in profits for retail stocks. If our portfolio contained SEARS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: S)") else Response.Write("(NYSE: S)") end if %> and WAL-MART <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WMT)") else Response.Write("(NYSE: WMT)") end if %>, both stocks would have taken hits, which would have constituted half our portfolio. The bottom line can be severely affected by news events like this. If, on the other hand, we're properly diversified and only one stock is in this sector, we stand to take less of a hit. With proper diversification, we can even make an effort to follow the less volatile industries, or sectors, thereby giving ourselves a safety cushion. These days many people are overweighted in the technology sector. With all the problems this sector is facing, many investors are taking tremendous losses due to lack of diversification. When you're putting together a portfolio, keep your stocks varied. Leave yourself a margin for error. The headaches will be fewer and farther between. And, should you decide to avoid speculative stocks, try to keep your choices in less volatile industries. As for the Fool 4, the diversification this year has helped make this a rather boring portfolio. When considering how "exciting" it could have been, boring is good. Not only is the method of investing simple, the fact that it is boring has helps us to relax. What a great way to invest! Again, let me remind you of the Motley Fool April Fool's Day party. Come join your favorite MFs for food and fun! Link up online with other Fools across the country. I'll be there for the Chicago area party, and I'm looking forward to seeing you all. But make your reservations early! The tickets are going fast! See you there!
(c) Copyright 1997, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool. |
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