The importance of a balanced portfolio
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The importance of a balanced portfolio

Investing in the stock market can be a very rewarding and lucrative experience ...

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Everyone has heard the old advice to never put all your eggs in one basket, and that adage is certainly true when that basket is your investment portfolio. Investing in the stock market can be a very rewarding and lucrative experience, but it is important to spread the risk of that stock portfolio across a basket of different stocks, and across a variety of different industries.

The reason for this diversification is obvious. If one of the stocks in a diversified portfolio suffers a large loss, the loss to the overall portfolio is likely to be very small. If, however, that stock represents a significant percentage of the portfolio, the loss could be devastating.

Of course achieving the level of diversification recommended by financial experts can be difficult, especially for the small investor. Many financial advisors recommend that no one stock make up more than 4% of the overall stock market portfolio. That level of diversification, of course, means that the investor will need a basket of at least 25 stocks, and that can be prohibitively expensive for many individual investors.

One great way to keep costs down while achieving an excellent level of diversification is to invest instead in a quality index mutual fund. These mutual funds work by pooling the funds of many different investors, and using those funds to purchase all the stocks in a particular index, such as the Standard and Poors 500 or the Total Stock Market Index.

One of the best things about this diversified approach is that the investor will enjoy the return generated by the underlying stock index, without the broker fees associated with buying the stocks individually. This approach also helps to avoid the risk of underperformance, the risk that the stocks you pick will not do as well as the stock market as a whole.

Another important advantage of the diversified index fund is low cost. These index funds require no expensive money managers, so the fees they charge are generally much lower than for managed mutual funds. It is important of course to shop around at several different mutual fund companies, and to compare the return the fund has achieved to that of the relevant stock market index.

For those with the funds to build a diversified portfolio of their own stocks, it is a good idea to seek out a low cost broker, and there are certainly a great many low cost brokers to choose from. It is also important to be aware of any fees or charges that may apply to smaller accounts. Many brokerage firms waive many charges for their high dollar clients, but they may charge higher fees to those with lower balances.

Whether you purchase a high quality index mutual fund, buy individual stocks or take a mixed approach, however, it is important to carefully diversify your stock market holdings. Holding a diversified portfolio of stocks is one of the very best ways to mitigate the risk inherent in the stock market. (don)
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