A Diversified Portfolio
But sometimes the market changes directions for reasons that aren’t so clear. There’s no hard and fast rule about when or how often these changes will occur, and no foolproof way to predict what will happen.
|Description||Where to Get|
| S&P 500 index and DJIA |
Extensive media coverage
|High volume, making them among the easiest investments to trade|| |
Higher prices, and sometimes limited growth potential
Some risk of company failure
|Mid-Cap|| Russell 1000 index |
Some media coverage
|High volume, making them easy to trade|| Potential for greater growth than larger companies |
Some risk of company failure
|Small-Cap|| Russell 2000 index |
Little coverage until price has gone up dramatically
|Small volume and low liquidity, making them potentially difficult to trade at the price you want|| Often lower prices, with big gains possible |
Higher risk from company failure or poor management
CYCLICAL vs. COUNTERCYCLICAL
Owning a cyclical stock can be a good investment, especially if you own it at the beginning of a bull market, when prices in general tend to head up. But if you own only cyclical stocks, the value of your overall investment portfolio may stall or shrink when the economy slows down.
Other stocks, sometimes called countercyclicals, tend to be more price-stable in good times and bad. Typical countercyclicals are companies that provide necessities, such as food, electricity, gas, and health care. Owning countercyclicals can help protect you in a bear market, when prices in general head down. But if you own only price-stable stocks, you risk missing an opportunity to profit when cyclicals generally start rising again.
SPREAD THE WEALTH
One way to protect your stock portfolio is to diversify your holdings. Using a diversification strategy, for example, you would buy stock in some cyclical and some countercyclical companies, in some large companies and in some small ones, in some new industries and in some older, more established ones.
With a diversified portfolio, your investments are cushioned when the market hits bumpy times. That’s because when you own stock in several different categories of companies — and as your portfolio grows, in a number of different companies within each category — the chances are that when some stocks lose value, others will gain.
Volatile stocks—such as small company and new company stocks—sometimes climb steeply, but may also lose value quickly. A portfolio made up primarily of small-cap stocks will tend to be volatile even if the companies are in very different industries.
Big companies are generally more price stable—another way of saying less volatile—than small companies. They have established track records, greater financial reserves, and experienced management. However, that doesn’t mean they can’t lose value or underperform in some markets.