Page 208 -

Diversify Y our Investment Por tfolio

you’ve got to reach for rewarding opportunities when risk is low—and actively
protect yourself when risk is high.
The Securities and Exchange Commission (SEC) offers the conventional
wisdom concerning asset allocation. The SEC says that, “Savvy investors typ-
ically do not change their asset allocation based on the relative performance
of asset categories—for example, increasing the proportion of stocks in one’s
portfolio when the stock market is hot. Instead, that’s when they ‘rebalance’
their portfolios.”
That’s a good plan—most of the time. But not always, and those excep-
tions can make a big difference. History shows that bull markets typically
go higher than people expect, and the damage from bear markets can be
worse than you might think. If you prefer not too pay much attention to
your investments, you may not want to take advantage of good market con-
ditions or protect yourself during downturns. But if you’re actively involved,
common sense tells you that you should improve your potential rewards
when conditions are favorable or limit your risk when the going gets
rough.
Here’s why: If you don’t act early to contain damage to your fi nancial
security, the emotional impact from an extended market decline could cause
you to react too late—and near the time that a great buying opportunity
occurs.

Look for Different Types of Stocks and Bonds

Now let’s take the management of your investment portfolio a step further

and talk about diversification. In addition to allocating your investments
among stocks, bonds, cash, and possibly other asset categories, you’ll also
need to spread out your investments within each asset category. This enables
you to reduce risk and perhaps improve your investment returns. The key
here is to understand that the various types of stocks and, to a lesser extent,
bonds, will perform differently as economic and investment conditions
change. As I explained in Chapter 16 , “Grow Your Retirement Nest Egg with
Stocks and Bonds,” different types of stocks and investment approaches go in
and out of favor.
In the U.S. stock market, there are more than 5,000 actively traded indi-
vidual stocks. Many investment analysts divide the U.S. equity market into
nine investment-style “boxes.” This system consists of three categories of
company stock, each with three sizes based on market capitalization (the total
value of a company’s outstanding common stock).

185

8/23/07 3:26:25 PM
c17.indd 185
c17.indd 185 8/23/07 3:26:25 PM