How Much Diversification Do You Need?

In regards to the topic of diversification, reader Wayne had this to say:

I have $40,000 invested in 10 different funds. I read in one of your articles that I only need to be in 2 funds with that amount invested. Should I just pick 2 index funds from your recommended list? How do I diversify into stocks, bonds, international and domestic?

To my way of thinking, before you can discuss diversification, you need to first decide on which investment strategy you are employing.

For example, if you are simply buying and holding, you need to have a different fund selection approach as opposed to trend tracking.

With B&H you are always exposed to market risk with no safety net in place. That makes it imperative that you own funds/ETFs in your portfolio that (hopefully) will zig when the market zags. Traditionally, this task of neutralizing, when equities head south, has fallen on the bond portion, which in the 2008 debacle did not turn out as planned.

If your mode of operation is trend tracking along with the use of trailing sell stops, then you can go for growth, if that’s what your objective is, without having to worry about a bond portion to bail you out.

Not knowing your circumstances, I can’t comment specifically. However, I have clients with portfolio sizes similar to yours that are invested in 3-4 ETFs covering a broad spectrum, which have produced good returns.

So yes, for a $40k portfolio, you can use 3-4 ETFs, or index funds, and cover just about most of the investment arenas that are worthwhile to be exposed to.

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