292 Chapter 6 Investments
$9,000
$10,000
$11,000
$12,000
$13,000
$14,000
ValueTime$2,500 Each PortfolioPortfolioAn investment portfolio is a mix of investments in different securities. Our four-stock mix
above is a simple example of a portfolio. Portfolios can include stocks and/or other invest-
ments such as bonds and commodities, and real estate as well. By investing in a portfolio,
instead of any one single security, an investor seeks to obtain a good return on the invest-
ment while limiting the risks posed by “putting all your eggs in one basket.”
In our illustration above, we created an investment portfolio by splitting our invest-
ments equally among four stocks. There is not requirement, though, that the investment
be equally divided; if we felt more strongly about some of the stocks than others we could
have put more money into some and less into others. Also, it should be noted that, while we
used only four stocks in our portfolio here (to keep the illustration manageable), in practice
a diversified portfolio is likely to contain many more different investments—often hun-
dreds or even thousands. The greater the number of different investments that a portfolio is
spread out among, the less impact that any one particular investment can have.
A portfolio that spreads its investments around a broad range of investments is referred
to as a diversified portfolio.Asset Classes
Diversifying across different stocks allows us to mitigate the risk that any given company’s
stock may perform badly. But what if the overall stock market takes a slide? In our example,
while Blunderbluff’s stock was a terrible performer, the other three did reasonably well. Even
DDKind, while a laggard, still didn’t fare too badly. Sometimes, though, the stock market as a
whole drops—taking down both good stocks and bad. No matter how many different stocks
you have in a portfolio, if the stock market as a whole fares badly, your stock portfolio as a
whole is not likely to do all that well, even if it contains terrific companies.
But stocks are not the only game in town. An investment portfolio can be further diver-
sified by including other types of investments, which may behave differently than stocks.
After the September 11 terrorist attacks, the U.S. stock market, not surprisingly, fell into a
slump. Yet prices for U.S. government bonds generally rose, as frightened investors looked
to put their money into “safe haven” investments, driving up the demand for, and hence the
prices of, government bonds. A portfolio that included both stocks and bonds would most
likely have lost money on its stock investments during that period, but this loss could have
been at least partially offset by gains from its bond investments.
Of course, stocks and bonds don’t always move in different directions. During much
of the 1990s, both stock and bond prices were strong. While both can go up, it is also
true that both can go down. Investors seeking greater diversification can construct portfo-
lios to include a wider range of investments, including such things as foreign stocks and
bonds, commodities, and real estate. But no amount of diversification can insure against
all risk. Still, the general idea at work is that the greater the diversification, the greater the
likelihood that when all the investments are put together they will on average produce a
reasonable return with an acceptable degree of risk.