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What are some other reasons why I should diversify my investment portfolio?

Diversification will not guarantee that you won't lose money or make big gains with your investments. But it will help you to have a portfolio that matches your appetite for risk, especially if your investment choices are less relatively tied or correlated. The most important point about investment portfolio diversity is that in a perfect world, while the value of your total portfolio will increase less than your best-performing investment, it will never do worse than your worst-performing investment.

What are some important questions to ask myself when managing the diversity of my portfolio?

Some of the more important questions to ask yourself include:

• What capital have I committed to investing in various investments? Am I reinvesting the proceeds? If so, into what investments?

• Is my portfolio out of balance because of this, and into what areas of concentration?

• What is the value of each category of investments in my portfolio, and what would I like it to be today, and in the near- and long- term future?

• What investments have I made lately, and in what categories?

• How have my investment choices and the values created today changed over the past one, five, and ten years?

• Have I kept the losers?

• Have I created more winning investments?

• What investments am I thinking of acquiring next, when, how much, and why?

• Will I sell something to do this, or will I invest new capital into this idea?

What is "correlation"?

Using historical returns on individual investment choices, you can see if two investments move in the same way, using various statistical analysis methods. If two stocks are 100% correlated over some time period, this means they move exactly the same way, given some event or market condition. If they are 50% correlated, then approximately half the time, over some period of time that is analyzed, the two stocks move in the same way, either up or down or even flat, with no change. If the correlation is -50% between the pair of investments, it means that they are moving in opposite directions, so as one goes up, the other goes down. As you build a diverse portfolio of investments, it is generally accepted that good investors, over time, find and invest in different classes whose returns do not move in the same or similar fashion.

 
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