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Diversification is a word financial planning pundits love to bring up every chance they get. So, by now, you know that spreading the holdings in your portfolio around increases your gains and reduces your risk. But how many stocks does it take to have an optimally diversified portfolio? And how much do you really need to invest to reach that mark?
Your first instinct may well be to opt for a mutual fund or two and leave all this talk of diversification behind. That’s a very good idea for individual investors, but experts like Tom O’Hara. chairman of the National Association of Investors Corp., say groups should jump headlong into the stock market. In his eyes, clubs aren’t the place to put the bulk of your savings. Instead, they are a great place for individuals to learn the ups and downs of stocks, but only if they research companies before purchasing shares. “Investment clubs are a wonderful place to learn information that will help you with your personal finances.” says American Express financial advisor Deborah Breedlove, “but you should handle retirement or other personal funds on your own.”
Members of newer clubs may think this is all out of reach. The average investment club is nine years old with a portfolio amounting to $89,000, a sum that can easily be spread about a number of companies in a variety of industries. But, while year-old clubs likely have a portfolio amounting to $2,000-$3,000, O’Hara stresses that’s no reason to lump all of your investment dollars in one place.
When New Jersey-based Ebony Prospectors Investment Club was started two years ago, diversification was one of the first issues the group’s 13 members grappled with. By October 1995, just two months after the club was established, members made their first investments with just $780. Member Anne Joyner says Ebony Prospectors then divided the money between McDonald’s Corp., the insurer AFLAC and semiconductor manufacturer Motorola. Three months later, they added Mobil, Synovus Financial and Intel to their portfolio. To date, the club’s total return has been 14%.
At first glance, dividing $780 among three companies may seem like a stretch, but according to NAIC, the average one-year-old club holds eight companies in its portfolio. However, it doesn’t take a lot of companies to successfully diversify a portfolio. Sure, adding a number of stocks means you’re open to less risk of one company sinking and taking you under with it. But to achieve true diversification, you need to spread your investments across various industries that move at different parts of the economic cycle. Ebony Prospectors did that by investing in the restaurant, insurance and semiconductor industries at first and then adding oil and financial stocks to the mix.
There are limits. “During the first year for the average club, I wouldn’t advise going beyond 12 stocks,” says NAIC’s O’Hara. “The more stocks you have, the harder it is to keep track of them.” On the flip side, Randall Eley, president of the Edgar Lomax Co., a 10-year-old money management
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