Over the last year, the share prices of Kier and Thomas Cook have fallen by around 88% apiece. Clearly, the two companies are enduring highly challenging periods that could continue over the near term.
While it’s disappointing for any investor with shares in one or both of the companies, it brings to light the importance of having a diverse portfolio of stocks. Failing to do so could mean an investor is exposed to a high degree of company-specific risk that ultimately causes a significant amount of volatility over the long run.
Although all investors would love to be able to pick just a handful of top-performing shares to hold within a portfolio, the reality is that poor performance can be exceptionally difficult to accurately and consistently predict.
Certainly, some risks can be identified. They may include weak consumer confidence for retail shares, or the prospect of a challenging economic period that may impact negatively on a wide variety of sectors.
But in some cases, profit warnings and financial challenges are unforeseen by even the most experienced investors. As such, it makes sense to reduce company-specific risk, so if one holding within a portfolio experiences a declining market valuation, its impact on the wider portfolio is somewhat limited.
Of course, there will always be an element of risk from investing in the stock market. It’s impossible to diversify away market risk, which is the prospect of market cyclicality affecting a portfolio’s valuation, without buying other assets.
But, over the long run, indexes such as the FTSE 100 and FTSE 250 have always recovered from downturns to post higher highs. Therefore, investors may wish to focus on reducing company-specific risk, rather than market risk, should they have a long-term time horizon.
Furthermore, having more stocks within a portfolio may allow an investor to capitalise on a wider range of growth trends within a number of different sectors and regions. Since there are a variety of appealing trends and industries at present that could offer strong growth prospects over the long run, now could be a good time to consider increasing a portfolio’s diversity.
With the cost of buying and selling shares having fallen significantly in the last couple of decades, owning a wide range of stocks is becoming cheaper. For smaller investors who wish to reduce their commission costs even further, the regular investing services offered by online sharedealing providers could cut the cost of buying shares to as little as £1.50 per trade.
Doing so could allow you to limit the impact of poor performances such as those recorded recently by Kier Group and Thomas Cook. With a rapidly evolving economic outlook, there are likely to be other shares that significantly underperform the wider index over the coming years. Although diversification may not help you to avoid them completely, it could mean their performances do not destroy your portfolio’s overall growth trajectory.
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Peter Stephens has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.