Principle 9: Diversify to reduce risk of loss

I f you’re a frequent reader of personal finance books and articles, the word “diversify” in its financial context should not be new to you. This is one of Andrew Stotz’s most valuable principles when it comes to investing your hard-earned money.

As discussed in previous posts, the award-winning financial analyst and public speaker advises that having 10 stocks of companies belonging to different business sectors and/or countries could be considered your investing seatbelt. Having 10 stocks may be manageable for people who have the time, interest, and knowledge required to successfully pick their own stocks. To be able to reduce the risk of loss, we should avoid buying stocks when they’re high and avoid selling when they’re low. The rote, unemotional approach of cost-averaging, buying the same nominal amount of stock at regular time intervals, helps achieve this end automatically.

Another technique that the Bangkok-based adjunct finance professor advises is to buy stocks outside of our home countries to offer protection against a local-economy collapse.

We know that not everyone has all three required elements (time, interest, and knowledge) to pick individual stocks on their own. A great way to diversify a portfolio is via a passive fund. Owning a passive fund is already a great step to diversification as long as you allot a certain amount of cash every month to contribute to your fund.

The only concern that we should be mindful of are the fees we pay for every trading transaction we execute. For conservative investors that might have money in bank accounts that are gaining almost zero in interest, it might be time to place them in bonds instead. It’s not a magic bullet to getting handsome returns, but this approach offer better interest than available from savings and time-deposit accounts while still mitigating risk. Mr. Stotz also suggests investors in their 20s have an ideal division of 90% equities and 10% bonds. As they grow older, they are advised to increase the portion of their bonds accordingly.

If you’re worried that holding periods would render you financially helpless in case of emergencies, leave a reasonable portion in an ATM account. As they say, don’t put all your eggs in one basket.

Andrew has written two academic papers on diversification that are available for download: Ten Stocks are Enough in Asia and Eight Stocks are Enough in China.

Danielle covered the three-day university tour of Andrew Stotz in the Philippines from October 2 to 4, 2014. She will discuss each of Andrew’s 12 investment principles from her perspective. All articles will be posted here on www.andrewstotz.com.

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