So, I’m back from a business-related vacation and am catching up on some of my administrative and financial errands.  While thinking about making my next big investment purchase, I had a little insight about diversification.  I have no idea if this is genuinely “new” or not, but it is certainly a new way of thinking about it for me.

Usually diversification advice follows such guidelines as “never more than 10% of your portfolio in one stock” or “not more than 20% of your portfolio in one fund.”  Additionally, comments I read from other bloggers and friends online suggest that you want to have at least $500 or $1000 at a minimum in any given stock for it to be “worth it” (at least that’s the assumption that I’ve gleaned).  [Of course we all know that if you "DRIP" it's quite easy, feasible and even recommended to invest smaller sums than that (to read more of my thoughts and experience with dividend reinvestment plans click here).]

The thought that I’ve just had, though, as I sit here trying to doll out my investment rations, is that perhaps we should or could also think about diversification in relation to how much the given sum of money means to you.  If you make $40,000 a year and for some reason get an unexpected bonus or gift of $10,000 (a quarter of your salary), I’m guessing that chunk of change is going to be very meaningful to you.  You might really want to protect it and take advantage of receiving it all at once.  So naturally you might want to be extra sure you properly diversify so as to protect your principal as much as possible (even if you’re planning on investing for growth).  So you might want to “over”-diversify a bit just to be extra sure and feel as safe as is possible going forward.  Example: the 10% guideline would tell you to put $1000 (at a maximum) in each stock.  But you might feel more comfortable making that no more than $500 in each stock.

On the other hand, if you make $40,000 a year and receive a $1000 bonus or gift, it probably wouldn’t be as meaningful.  It’s less than a month’s salary.  You can “make it again” quite easily.  So you might feel even more comfortable taking that $1000 and putting it all into one stock.

What’s interesting is that in each scenario above, you still might be putting $1000 into one stock.  This does illustrate the relativity of perception surrounding the worth of money, and in both cases, the individual stock risk is going to be the same (if you invest $1000 in HippyTown Bank and they go under, it’s not going to matter whether you also have several other holdings or not).

Adjust your diversification requirements on the basis of what (or how much) the money means to you.

If one wanted to proceed strictly mathematically, the 10% guideline should be followed regardless of the size of your total investment.  But if you only have a bonus of $1000, that would mean putting $100 into each stock.  If one of those stocks crashed, you’d only be out $100 and if you’re making $40,000 a year that might not feel like much at all.  Hence considering moving the diversification guideline up a bit to take into consideration how much a given sum of money means to you.

I guess these thoughts build a little bit on what I was saying in a previous post about letting our emotions get involved in our investing.  We should take into consideration what any given sum of money means to us.  Of course money and currency are fungible (i.e., completely interchangeable) - one ten-dollar bill “is the same” as any other ten-dollar bill, but that’s comparing it to itself.  One ten-dollar bill is not the same ten-dollar bill to an investment banker as it is to a young student working for eight dollars an hour at a coffee shop.

What do you think?  Is this something you’ve already been putting into practice?

In my own case, the amount I’m investing is actually meaningful to me since I don’t often receive this amount all at once and I really want to make the best use of it.  I want to maximize my yield opportunity but not sacrifice proper diversification.  I haven’t made up my mind yet on which stocks I’ll put it in, but they’re going to pay me good dividends and they’re going to be somewhat conservative (as stocks go).