Devoted to understanding the basics and fundamentals of investing

You always hear how you need to diversify your portfolio, but how do you go about doing it? I wanted to talk about different ways to diversify your stock portfolio, as well as speak of portfolios that are not diversified at all to give you some examples of what you don't want to do.

There is not a single way to diversify your portfolio. There are many different ways to diversify and not have all of your eggs in the same basket. Diversification can  come through mixing small cap stocks with large cap stocks. It can also come through mixing growth stocks with value stocks, or even investing overseas and investing here in the United States. The most common way to diversify most often is to pick stocks in different industries. For example, a good way to diversify is to choose a stock in the technology sector, energy sector, transports sector, financial sector, and so on. By spreading your investments out, you are able to keep your portfolio away from market risk. Your portfolio is much more at risk when you have correlating stocks, that could trade on the downside together based on the same news.

There are several ways where one can be undiversified as well. A common mistake that investors make is owning too many shares in one company. If one stock is over 50% of your portfolio then you are certainly not diversified. Many investors own too much in the company they work for. It is completely fine to own shares in your company, but make sure it is still under 25% of your overall portfolio. It is also not a good idea to buy shares of stock in similar companies. A good example would be buying stock in both GM (NYSE: GM) and Ford (NYSE: F). This would be a bad idea because these companies are exposed to the same economic pressures and are likely to both come under pressure at the same time.

A final tool that can also diversify a stock portfolio is the sometimes forgotten cash. Having some cash in your portfolio is a good idea for a couple of reasons. First, if you find a stock that you want to buy quickly, you will have that cash available. Second, when the market is in a bearish mode, cash will be the best save haven. Too much cash will keep you out of possible great returns, but having 5-10% cash at times isn't a bad idea at all. 

Diversification is all about risk protection and being able to weather the storm, while still doing well in bull markets. Your stock portfolio should always have plenty of mixed of small and large, growth and value, and a wide array of sectors. If your stock portfolio is diversified you are far more likely to be successful in the stock market.