President Lincoln once said that if he had eight hours to chop down a tree, he would spend seven of it sharpening his saw.  With stock market trading, your diversification allocation is an important strategy to make your investments successful.  The question then is concerning what asset classes to choose, what percentage of your investment goes in each class and what sectors and stocks do you put your investments in for each asset class.

This is probably the most important decision you will make as far as your investment strategy.  Therefore, as President Lincoln advised, do not short your time with this question.  Spend some time looking at the asset classes and their expected return and the standard deviation.  Use an asset allocation calculator which is available online to plot your ideas and see how they fit together.  One example of a calculator can be found at http://www.dinkytown.net/java/AssetAllocator.html.  It allows for input on your current situation and gives a possible start on an allocation formula.  Another site that helps determine asset correlation that is really good is at  http://www.assetcorrelation.com/user/enter_custom_port.

Stock diversification is important because if you have all your investments in like kind asset classes, if the asset class or particular sectors within that asset class has a bad period of time, your entire investment has a bad period of time.  One definition I cam across said that  diversification is the process of spreading your money among different investments to reduce risk.  By picking the right group of investments, you may be able to limit your losses or enhance your gains.

That is certainly the rub.  What group of investments do you select.  After checking their credentials, a financial planner or stock advisor may be a good person to check with.  They can give you advice as to how to begin.  You can plug their ideas in the asset allocation calculator and check if it fits your strategy.  Your strategy will certainly be finessed over a period of time as you test your theories.  This is not bad.  As stated in another area, you can test your theories with play investment sites before you enact it for real with your money.

One analysis I read about suggested putting a portion of your investment in commodities and real estate investment trusts (REIT’s).  The argument is that even though these asset classes are volatile, they will go a long way toward diversifying your portfolio.  Another book I read said that if you invest in REIT’s, than move a portion of your small cap funds to that asset class.  That is an idea you would need to look at and see if it fits your strategy.  Certainly, commodities are a little riskier and volatile.  When the market is down, people move toward them.  However if the dollar strengthens and the market improves, these suffer.

The advice then, is to take your time initially.  Sharpen your saw and determine the correct strategy and mix for you.  Then stick with the system.  You did your homework up front, then trust your system.

Tags: commodities, investment, reit, standard deviation, stock market trading