Which of your investments worried you most during the recent market correction? If it was one of your smaller holdings, you're not alone.
We all have only so much time and so many brain cells to devote to investing. If you're focusing yours on a tiny portion of your investments, the majority of your net worth is going unwatched.
Many investors I speak with are focused on only one or two of their investments or, worse, are fixated on the one they sold which has since gone up in price. Have you ever taken a flier? Bought a few shares of something on a tip?
Stop and ask yourself: suppose this purchase doubles or triples, what impact will it have on your net worth? It will be insignificant. And, any change to your net worth will be dwarfed by the movement of your primary investments.
Let's put some numbers to this. If you have a stock or mutual fund which is 1% of your total portfolio and it doubles in value, it's now only 2% of your total holdings. Your net worth has only increased by 1%. And, let's face it, despite what we think, it's unlikely that many (or even a few) of our investments will double over the short term.
The key to building a strong investment portfolio is to set your goals and diversify, but not have so many investments you can't follow and to avoid investments which are too small to be meaningful. Here are some rules of thumb: no stock or bond should be less than 2% of your portfolio.
No mutual fund should be less than 5%. If you're uncomfortable holding that much of a particular stock or fund, the investment is too risky for you and you shouldn't own any of it. Think about the 2% and 5% guidelines for a minute.
If you own only stocks, that would be a 50 stock portfolio, a lot of stocks for anyone to follow. It would be 20 mutual funds. In both cases, more securities than you need to achieve diversification. So the above percentages are only minimums.
The maximum holding for a stock should be 5%, that's 5% of your net worth tied to the fortunes of one company (remember Enron, if you're wondering why).
For mutual funds, the bigger and safer the fund's investment focus, the more you can invest in it. Bigger and safer means, for example, Big Cap stocks for both domestic and foreign funds, investment grade bonds and US Treasuries. To be conservative, you should put no more that 10% of your next worth into any one fund.
This brings us to index funds. If it's a fund mirroring a big index, i.e., the S&P 500, the Lehman bond index, the Morgan Stanley Japanese stock index, you can invest more than 10% in a single fund. If it is a smaller index, i.e., the technology sector, the 5% rule applies.
Diversify, but don't have so many investments that you can't follow them all. Avoid investments which are so small they won't make a difference. Focus on the big picture; don't let the tail wag the dog.
Author Resource:-
Bill Byrnes is co-founder of MUTUALdecision, top mutual fundsa, providing investors with data on the top mutual funds, and author of the MUTUALdecision Blog. He's been CEO, chairman and served on the board of directors of several public and private companies. He holds MBA and JD degrees and is a Chartered Financial Analyst with over 30 years experience in the investment industry.
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