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Rule 5: Diversify to Control Risk

If you control the downside, the upside will take care of itself.

I have always believed that to be the case.

But controlling the downside means managing the risk.

The biggest risk out there is sector risk.

I don't care how great a tech stock was in 2000 -- even eBay and Yahoo! --

if you had all your eggs in that sector, you got scrambled.

Same with the financials in 2008.
Or oil from 2014 to 2016,  

What can keep you from getting nailed by sector risk, which is about 50% of the entire risk of owning a stock?

Diversification.

It's the only investment concept that truly works for everyone.

If you can mix up enough different sectors in your portfolio,
you can't be hit by one of the myriad perfect storms that come our way far more often than you would think.

So why aren't more people diversified?

Many amateurs don't even know the stocks they buy. They end up with stocks that are frighteningly similar.

When I started playing "Am I Diversified" on my radio show in 2001, I was blown away by how few people knew just how undiversified they really were.

I still field quite a few calls from people who genuinely think that owning FANG is a diversified strategy.

Hardly.

You own variations of the same thing: social, mobile, cloud and they trade together.
That's faux diversification.

No matter how much I may like oil stocks at any given moment, I can't stomach a portfolio made up of ExxonMobil, Chesapeake Energy and Halliburton.

I will always say no to a portfolio of JNJ, Eli Lilly, Allergan and United Health even as I like all four.

They just leave you exposed to health care risk that could overwhelm any of these stocks.

Having an undiversified portfolio is not just an amateur mistake, though.

Many professionals don't like to be diversified because of the bizarre way money is run in this country.

If you concentrate all your bets in one sector and the sector takes off, you will beat pretty much every diversified fund out there.

That's the nature of the beast.

You then can market yourself as a huge success
and get profiled by every magazine
and take in capital from unsuspecting folks who don't know how much risk you truly are taking on.

Both the amateur and the professional are wrong; controlling risk is the key to long-term rewards and controlling risk means being diversified

AT ALL TIMES.

Action Alerts Plus portfolio manager and TheStreet's founder Jim Cramer has learned a lot over his 30+ years of investing. So he created a list of 25 Rules for Investing that can help you avoid the novice pitfalls that even he fell into on occasion.

One of the many things he believes is that "if you control the downside, the upside will take care of itself."

And the only way to control the downside is to diversify your portfolio. 

Rule 5: Diversify to Control Risk

Sector risk is one of the biggest mistakes investors make.  If you have all your eggs in one sector, you get scrambled, he says.

"If you can mix up enough different sectors in your portfolio, you can't be hit by one of the myriad perfect storms that come our way far more often than you would think."

That's why Cramer believes that diversification is the only investment concept that truly works for everyone.  

Watch the clip above to hear why!

Sign up and watch Jim Cramer's 25 Rules For Investing here!

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