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Portfolio Investments and Understanding Failure to Diversify

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Investors of the financial needs of others must avoid stock fraud with concentration and ensure that their client receives a diversified portfolio otherwise a client may have the ability to form litigation.

Diversification of investment holdings is the most important shield against risk. Since some investments rise in value while others fall, diversification smoothes out some of the volatility of the overall return from a portfolio. Diversification may sacrifice some of the upside potential, but should be more than offset by the benefits of lower levels of risk.

Diversification is a strategy for managing a customer portfolio to limit risk. Instead of all the investments being concentrated in one market sector, investments are diversified among a variety of industry sectors and types of security.

Therefore, as it is less likely that all of the major sectors or specific types will be hit with a significant downturn at once the portfolio contains less risk.

It is a broker's responsibility to advise clients to diversify their portfolio to reduce risk. When individual stocks are purchased, it is extremely important that proper diversification issues are met to have a fully diversified investment portfolio.

The risk of loss increases greatly when failure to diversify occurs and an investment portfolio is over-concentrated within a particular type or industry sector or security. It is the broker's obligatory duty to inform a client of risks and actions that attribute to these risks. Over concentration in an account that contains only one individual investment is easy to recognize. Accounts may also be over concentrated if they:

* Contain only common stocks (including mutual funds that invest in common stocks) rather than a mix of common stocks, preferred stocks, and debt instruments (bonds).

* Contain investments that are limited to one particular industry (such as telecommunications) or industry sector (such as health care or finance).

It is imperative that when an investor takes on a new client the adequately evaluate and understand that client's investment wants and needs as well as to then provide them with a diversified portfolio. If failure to diversify occurs and a client's investment portfolio is placed largely in one sector, and if that sector shows significant losses, an investor may be liable.

All investors are unique, and careful strategies must be employed to properly diversify a client portfolio. Failure to do so can result in negligence and malpractice liability when that portfolio sustains significant losses.

The cause of action for negligence or malpractice is based upon the duty owed by the broker to the customer and the breach of that duty, including the duty to exercise due care in connection with the account. This activity, whether accidental or not may still be considered negligent misrepresentations, especially if finances are lost.

Failing to properly diversify the customer's account may also be considered negligent management of an account.

In general, reports have shown that:

* Smaller companies typically have higher risk of failure.

* When investing, it's important to note that the markets with higher market volatility are the smaller-company stocks.

* Foreign securities have additional risks.

* Emerging markets typically have higher risk because they are underdeveloped markets.

The right level of diversification for a client depends upon a variety of factors, including the individual's financial position and long and short term financial goals, and how the market is performing. Many portfolios are not properly diversified and therefore an extended risk is being taken.

Article Source: http://www.articlemanual.com

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