Your Portfolio's Riskier Than You Think

We all know that individual stocks are risky. But if you want to make sure your portfolio doesn't fall prey to the next big market crash, how can you protect yourself against those risks?

Putting together the perfect portfolio
In this month's issue of the Fool's Rule Your Retirement newsletter -- which comes hot off the digital presses this afternoon at 4 p.m. ET -- Foolish retirement expert Robert Brokamp gives his answer to that question. His solution: take steps to create a suitable investment portfolio that addresses all of the risks investors face.

Risks like increased competition, changing economic conditions, and management effectiveness are integral parts of what makes some individual stocks so full of promise. Pick a company with a solid management team, good fundamentals, and promising products, and you end up with moneymakers like Apple (Nasdaq: AAPL  ) or Green Mountain Coffee Roasters (Nasdaq: GMCR  ) . If you get stuck without some of those positive qualities, then you end up with a Washington Mutual or an Enron -- with all the baggage and financial difficulties that accompany it.

Cover your bases
Obviously, if it were that easy, you'd just pick the good stocks and avoid the bad stocks. In reality, though, the solution most investors use is to diversify their portfolios with many different stocks. That way, even if they're wrong about a particular stock, they have many other good ideas that might work out better.

But as Brokamp discusses, there's been a lot of debate on just how many stocks you need in order to protect yourself from that kind of risk. The recent bear market showed just how interconnected many investments are, as it was extremely difficult to find stocks that didn't lose money during 2008. At one point, experts believed that all it took was a dozen or so different stocks to build a well-diversified portfolio. Now, though, some believe that number is closer to 50.

Moreover, that doesn't even necessarily incorporate all the different traits you want to see in at least some of your stocks. In particular, the best portfolio combines:

  • Both domestic and international stocks.
  • Stocks in companies of all sizes, from century-old behemoth General Electric to the new concepts you'll find with Shanda Games (Nasdaq: GAME  ) or nanotech specialist Harris & Harris (Nasdaq: TINY  ) .
  • Stocks covering a wide range of different sectors and industries within the economy.
  • Different investing styles, ranging from the value-investing concepts of folks like Benjamin Graham to momentum- and growth-focused investing.

How can you hope to come up with the dozens of names you'd need just to get a running start on a portfolio that covers all those needs? Fortunately, the answer is easier than you might think.

Falling back on funds
Picking individual stocks can be incredibly lucrative. But you don't have to use individual stocks for all of your investment ideas. Mutual funds and ETFs can be extremely helpful in giving you a quick and easy way to get the stock exposure you want without necessarily doing all the research you'd need to do before buying an individual stock.

Here's a quick example: Say you believe that health-care stocks in general will benefit from whatever the final resolution on health-care reform proves to be. You could simply pick some stocks in the sector and hope that they react the way you expect them to. But that might leave you exposed to company-specific risks that you may not have discovered.

Enter funds. An ETF like SPDR Select Health-Care (XLV) gives you wide and varied coverage of the entire sector. You'll get pharma stocks like Merck (NYSE: MRK  ) , biotech companies like Amgen (Nasdaq: AMGN  ) , and exposure to health insurers such as UnitedHealth Group (NYSE: UNH  ) -- all in a single investment.

Learn more
Of course, there are thousands of different funds to choose from as well. That's why Rule Your Retirement offers its subscribers a valuable service: its RYR Fund Shop. There, you'll get specific recommendations of funds covering all different types of assets. It's a great first-stop to judge how you can fill in the gaps in your portfolio.

To get a firsthand look, or just to learn more about how the right diversified portfolio can make a huge difference in your investing results, be sure to take a look at the new issue of Rule Your Retirement. If you're not already a subscriber, you can get a free look easily -- just click here for our free 30-day trial offer.

Investing sometimes seems scary, but it doesn't have to be. With the right portfolio, you'll protect yourself while still having a chance at the huge profits that the best stocks can bring.

Fool contributor Dan Caplinger covers his bases faster than Boston speedster Jacoby Ellsbury can steal them. He owns shares of General Electric. Green Mountain Coffee Roasters and Harris & Harris Group are Motley Fool Rule Breakers picks. Apple and UnitedHealth Group are Motley Fool Stock Advisor selections. The Fool owns shares of UnitedHealth Group, which is also a Motley Fool Inside Value recommendation. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy is a safe haven in a risky business.


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