3 ways to diversify your portfolio

Many investors run the risk of an overly concentrated portfolio. Here’s how to avoid that common mistake.

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When building a portfolio, investors employ differing approaches to picking stocks. One might prefer growth stocks, another may pursue value stocks. But no matter what style of investor you are, understanding risk and building a portfolio that accounts for risk and reward is very important.

Charlie Munger, business partner of Warren Buffett, is fond of a saying by author Mark Twain: “Put all your eggs in one basket and watch that basket.” While I’m not one to argue with Munger, his advice does have a number of caveats, particularly for investors just starting out. The major problem with Munger’s advice is that it assumes the investor won’t make any mistakes. While Munger and Buffett rarely do make investment mistakes, for most investors mistakes are a regular occurrence.

One way investors can reduce their portfolio risk but not necessarily reduce their potential returns is by allocating a portion of their portfolio to investing in Listed Investment Companies (LICs).

Argo Investments (ASX: ARG) is one of the oldest and largest LICs on the Australian Stock Exchange and has over $4 billion in assets. Argo has a superb track record and significant holding in many blue chip companies, which offers shareholders an immediate exposure to a diversified portfolio of some of Australia’s largest and most established firms.

WAM Capital (ASX: WAM) is an investment portfolio skewed toward medium and small companies. Since inception in 1999 the portfolio’s returns before fees and taxes have been exceptional. For investors looking to learn more about the evolution of LICs, Chris Stott, the Chief Investment Officer at WAM, recently penned an article that provides a thorough background regarding LICs that you can read about here.

LICs don’t only offer exposure to Australian shares either, which means they can also be used to introduce international diversity to a portfolio. A number of LICs focus on international shares, including Platinum Capital (ASX: PMC), which is managed by the highly respected international fund manager Platinum Asset Management (ASX: PTM). Platinum Capital offers shareholders a diversified portfolio of global shares that currently includes holdings in software giants Microsoft and Google.

Foolish takeaway

Particularly for investors making their first foray in to the stock market, using a Listed Investment Company as a starting point for your portfolio can be a wise move. Not only does a LIC give you immediate diversification, but many LICs pay handsome dividends too. As an investor’s skill and confidence grows, he or she may then look to add some carefully selected individual stock ideas to the portfolio.

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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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