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A Diversified Portfolio

You can build shock absorbers into your stock investments to cushion a bumpy ride.
The stock market as a whole moves up or down in value from time to time — a phenomenon called a market cycle. Sometimes the turnaround is predictable, and reflects economic or political events in a country or in the world. 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 Information Trading Risks and Rewards


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 Sometimes regular dividends

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


Some stocks tend to rise and fall with market cycles because they're more sensitive to changes in the economy than others. Called cyclicals, these companies operate in industries that flourish in good times. Typical cyclicals are airline or automobile companies or companies selling leisure-time products and services. 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.
YOUR PORTFOLIO A portfolio is a collection of investments. Your portfolio may include stocks or mutual funds, for example, or a combination of stocks and funds. You compute the value of your portfolio by multiplying the number of shares of each of your holdings by their current price. For instance, suppose you have 100 shares of Stock A priced at $20 a share, and 100 shares of Stock B priced at $50 a share. Your portfolio has a value of $7,000 ($2,000 (100 x $20) + $5,000 (100 x $50) = $7,000). If Stock A drops by $5, to $15, and Stock B stays the same, your portfolio value would drop to $6,500 ($7,000 – $500 ($5 x 100) = $6,500). However, changes in stock prices can sometimes offset one another and stabilize your portfolio. For example, if Stock B had risen $5 to $55, your portfolio value would actually stay at $7,000. And if Stock B increased even more, say to $60 or $70 a share, your portfolio would actually increase in value despite the drop in Stock A’s price.


Any time you concentrate your money in one place, your financial security depends on the strength of that investment. So a portfolio that’s concentrated in one market sector, or only in cyclicals, is in danger of losing value if that sector weakens, or the economy falters. 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.

bull market and bear market explanation

Another way to diversify your portfolio is by balancing volatility and stability. 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.


One important way to diversify is by spreading your investments across small, mid-sized, and large companies. A company’s size is determined by its market capitalization, which is computed by multiplying the number of existing shares by the current price per share. For example, a company with 100 million existing shares worth $25 a share would have a market cap of $2.5 billion.

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