Tuesday, August 5, 2014
A diversified portfolio of stocks would not contain all technology or pharmaceutical companies, for example. If there were a number of oil company stocks, they would be diversified between domestic and international companies, producers of oil and refiners of oil. They would not all be small cap or large cap. A bond portfolio would not be all triple-A-rated or all junk, but would instead be diversified throughout different maturities, credit quality, and issuers that don’t all come from the same industry. Asset allocation and diversification are somewhat related portfolio management techniques. Where they differ is that asset allocation puts set percentages of capital into various types of stocks, bonds, and cash to achieve strategic goals in regards to risk and reward. Within those allocations, we use diversification to balance the risk of one investment with the characteristics of another. So, 20% large-cap growth, 20% mid-cap growth, 30% small-cap growth, and 30% long-term bond is an asset allocation. Drill down into the “20% large-cap growth” category, and the various companies owned would come from different industries in order to maintain diversification.