You May Not Be as Diversified as You Think

Every portfolio, no matter how well it is constructed, is vulnerable to something.

Investors who rely on actively managed funds or broad-based index funds often end up too heavy in the financial sector; those who go with individual stocks and sector funds face a similar threat if too many of their holdings correlate too closely.

One less-obvious example of this problem is with emerging-market stocks and mining stocks. Both segments have been terrific sources of outperformance for several years, and there is a compelling fundamental argument in the growth rates and increased demand to tell us that both segments should continue to do well over the long term.

As this chart of iShares S&P Global Materials Index Fund(MXI Quote) and BLDRS Emerging Market 50 ADR Index Fund(ADRE Quote) shows, the correlation between the two has been very tight, including during several big and fast corrections. ...