You’ve heard that you should diversify your portfolio, but how varied do your investments really need to be? Play it safe with the 5 percent rule of investing. The rule states that no more than 5 percent of your portfolio should be locked up in one particular investment type. If you were investing in individual stocks, for example, you would want to invest no more than 5 percent of your money into a single stock.
If you invest not via individual stocks but through products like index funds or exchange-traded funds (ETFs), it can be slightly more difficult to determine the 5 percent rule; but it’s not impossible once you know where you look. You’ll want to check the holdings for each fund. Mutual funds are assumed to be diverse by design, but some of them can get lopsided in favor of stocks, bonds, or even precious metals.
You can also use the 5 percent rule to ensure your portfolio doesn’t rely on any one sector. Some funds focus on a particular industry, like healthcare or real estate, for example. But you don’t want your portfolio’s success to ride on either of those industries. Keep your allocation for each sector to 5 percent or less.
Of course, there’s an exception to every rule. One mutual fund can take up more than 5 percent of your portfolio if the holdings within the fund itself respect the 5 percent rule. You might choose a highly diversified index fund to take up a substantial chunk of your portfolio, while supplementing with smaller allocations to a few other funds.