Diversification is a time honored risk reduction method used in constructing investment portfolios. Usually it is recommended that the small investor own at least 5 stocks in 5 different sectors. While the concept is sound for the small or individual investor there are three problems. First, one may pick a stock that underperforms in an other wise strong sector. Second, stocks can be like time bombs. A major, unexpected blow up in one stock can lead to a major devastation of up to 20% of an investment portfolio. Third, working with individual stocks can be time consuming. To be done properly keeping up with developments in 5 stocks can take up 5-10 hours a week. That’s fine if you have the time, but if you have a demanding job and family it just may not be practical. Further, there are people who lack the temperament or skill set to properly research and utilize available information. For many people a practical alternative is called for.
One solution is to build a portfolio using closed end funds. Closed end funds have a fixed number of shares. Their price is determined by what people are willing to pay for them on the open market. They may trade at a premium or, more frequently, a discount to their net asset value per share.
Here is a sampling of closed end funds that could be used to build a diversified portfolio of closed end funds. Factual data is from cnbc.com and is accurate as of close of business 01/07/2010.
Tri-continental Symbol: Ty Price: $11.84
Established in 1929 this is the granddaddy of closed end funds. It invests primarily in large cap United States stocks. In a conservative portfolio it would probably be the largest holding.
Royce Value Trust Symbol: RVT Price: $11.13
This is a fund that invests in small cap United States stocks. Small cap stocks are a growth engine in a portfolio and typically about 20% of stock investment dollars would go into a fund like this.
Latin America Equity Fund Symbol: LAQ Price: $40.68
Foreign stocks should generally make up about 20% of a portfolio. It’s possible to invest in closed end funds that focus either on general regions or specific countries. The regional approach provides additional diversification.
Templeton Dragon Fund Symbol: TDF Price: $27.93
This fund invests in the Asia.
Central European And Russia Fund Symbol: CEE Price: $35.06
This fund invests in former Eastern block countries.
Spider S&P Emerging Middle East Fund. Symbol: GAF Price: $64.24
This fund invests in the Middle East and Africa. Investment opportunities in Africa are highly llimited and this is one way to play the last continent that is largely undevloped.
Cohen & Steers Total Return Real Estate Fund. Symbol: RFI Price:$9.75
This is fund that invests in a variety of real estate investment funds. About 10% of a portfolio belongs in real estate and this is way to diversify easily amongst numerous classes.
Full Disclosure: I am not employed in any fashion by any firm in the securities industry nor do I have a business relationship of any type with the companies mentioned. As of this writing I do have a small holding in LAQ. This is not an offer to buy or sell any security, nor is it a recommendation. These are simply my thoughts on these securities. Please consult your own investment advisor and research any security thoroughly before making any investment.