Keeping the discipline of putting no more than 5 percent of your portfolio in one particular position helps avoid significant losses in your asset portfolio. This applies to any asset class.
Imagine putting all of your retirement savings into stock issued by the company where you work…and then watching the stock decline due to conditions beyond the company’s control. This imaginary scenario became a reality for a lot of employees during past stock market meltdowns and individual companies’ stocks crashes.
Another investment mistake that pertains to position sizing is price leveraging. Let’s say you purchased 500 shares of a company “Z” at $50/share. Then the stock price falls to $30/share and you decide to buy another 500. Your average cost per share of stock now is $40 and you own 1,000 shares.
In one week the stock “Z” falls further, to $10/share. You decide to take advantage of yet another bargain and buy 1,000 shares more, so your average cost per share becomes $25. It is highly possible that the stock price will continue sliding and you may end up with a disproportionally high amount of bad investment….
I emphasize the importance of having discipline about position sizing and diversification so that you will never end up with disproportionally high amount of bad investments. Greed and emotions are worth enemies when it comes to investment.
Below are a few investment vehicles to consider for your Investing money that are diversified among different asset classes:
These are just examples of various asset allocations to consider. You will do just fine with diversifying among few asset classes. However, make sure that within each of the suggested investment classes you further diversify your holdings. For instance, have different stock positions (do not invest more than 5 percent of your stock market portfolio in one particular stock or bond) or different pieces of rental real estate.
Read more on this subject next week…
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