How to Diversify Investments and Why it is Critical

Diversification Is The Key To Successful Investing

They key to successful investing or trading is diversification. It increases your chances of winning or having a profitable portfolio. If you stop and think about it, it really makes sense. Are you going to put all your money in one investment knowing that nothing is ever guaranteed? No matter what strategy or technology you use, nothing can predict the Stock Market’s behavior.  Doesn’t it sound more logical to spread the risk out over a number of great investments so that if some fail you can still come out positive? This is the power of diversification, so let’s find out how to diversify investments!

A great example how diversification works is from the book The Intelligent Investor written by Benjamin Graham. In it he uses roulette to explain diversification. In roulette there are 38 numbers, 1-36 as well as 0 and 00. The payout for any one number is 35:1 (this means if you bet $1 on a number and you win, you get $35), but the chances are 37 to 1 that you will lose. This results in a -$2 margin. If you diversify and bet on every number you will lose $2 per spin because of this negative margin. Obviously, the casinos are a business and need to be profitable, so on average the casino will beat the player. Now let’s say instead there was a positive margin. A positive margin means if you bet on every number you would come out positive and make money. Let’s say the payout for each number was 39:1. Now each time you win you get paid $39. If you bet on every number you will get paid $39 and lose $37, making it a $2 positive margin. By using diversification, you can win every spin!

How To Diversify Investments

The roulette example does not mean diversification is buying every single stock available out there. Although this is what the Market is for the most part, and any portfolio performance is measured against the Market. The main goal of an investor or trader is to beat the Market or they would just buy the Market ETF and Mutual Funds. This is where it is key to diversify with the great fundamental and technical stocks. If you have a collection of great stocks and most of them beat the Market, odds are your portfolio will also beat the Market. Next let’s figure out how to find a collection of stocks that can beat the Market.

The First Step is Generating a List of Good Stocks

Using fundamental and technical analysis you can find the top performing stocks in the Market. Here are the steps to collecting your list of stocks to invest and diversify into:

  1. First let’s check the Current Market Conditions. You should only be buying into new stocks when Buying is in control and Market Conditions are Average/Good/Very Good. YP Investors Members can see the Current Market Conditions anytime on their Member Home Page. (If you aren’t a member yet, join with a free trial!)
  2. Next, start the stock selection by finding a list of fundamentally sound stocks. You can use YP Investors Fundamental Analysis tool to check any particular stocks fundamental health.
    1. Alternatively, if you don’t know fundamental analysis, go to YP Investors Top Stocks. Each week YP Investors publishes a list of new top performing stocks for you to use! This is a great starting point.
  3. Let’s use our list of fundamental stocks and check if they are Technically sound stocks to invest in. Using YP Investors Stock Selector Tool you can see the 5 important technical attributes. You want to keep stocks that have a positive trend (1 of the 5 attributes) and have at least 3/5 positive technical attributes.

Once you Have a List of Stocks, Diversify your Investments:

  1. Once we have narrowed our list to Technically and Fundamentally sound stocks we can start to diversify and buy into them. You will want to diversify them equally, so take your total cash available and divide it by the number of stocks on your list. Your portfolio list should be less than 100 stocks but more than 3 to get a decent diversification. I typically stick to less than 20 because it can be a lot to keep track of.
    • Entering/Buying Stocks: A great entry point for any stocks on your list is at any buy signals. Use point and figure charting to identify these buy signals. (We have a great Video Tutorial of Point and Figure Charting for you to familiarize yourself with the charts.)
    • Exiting/Selling Stocks: Any Investor or trader should always know when they will sell the stock before they buy it. This is another key to successful investing. You have to have that set price otherwise your emotions can take over and that is where you end up losing. Great exit points are if the market conditions turn Very Bad, if a stock ever turns to a negative trend, or sometimes if a stock hits a sell signal on point and figure charts. Using the trend method is more long term investing and is a great strategy. Whereas using the sell signal is more for trading and involves more attention to each stock you own.
  2. Repeat the process and continue to add stocks to your portfolio as you exit out of the stocks you owned. This will continue to keep your portfolio well diversified!

When You Diversify Your Investments You Win

Diversification is key to your success. It allows your fundamental and technical analysis to play out and provide the results you expect. It will also reduce your stress knowing that one stock/company cannot wipe out your accounts. Being able to sleep at night is definitely a key to success not only in the Stock Market but in life as well! We hope YP Investors is able to provide you the tools and knowledge to grow your wealth successfully. We want you to live the life you want, financially free. If you aren’t a member of YP Investors yet, try out our Investing Tools for free with a free trial here!

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