The one principle that everybody who is investing in stocks should learn and practice is diversification.
Diversifying stocks means that you buy shares in different kinds of companies in order to reduce the risks and increase potential gains.
The trick to diversifying is to find the package of stocks that will give you the level of returns you want at the level of risk you are willing to take.
This can take time but most people can do it.
Something to remember is that there is no such thing as the perfect portfolio.
The Level of Risk The first thing that you need to take into mind when you are diversifying is the level of risk that you want to take.
This means both the risk you are willing to live with and that you can live with.
If you are investing for short term income you might want to invest in slightly more volatile stocks that will give you a higher return.
If you are investing for long term income or retirement you might want to concentrate on stable stocks that are more likely to be around in the future.
Many experts recommend that you balance out the level of risk with a mix of higher risk and lower risk securities.
Since there is no perfect formula for this the best way to do it is the mix you feel comfortable with.
Ensuring a Return The ultimate goal of diversifying stocks is to ensure a steady or constant return in the future.
This means you need to pick a package of stocks that will offer both a potential of high performance and a steady return.
A person might choose several technology stocks for growth and a number of traditional industrial stocks such as railroads for a steady return.
It might also be a good idea to further diversify for example to purchase some foreign stocks or stocks in companies that tend to do well in a bad economy.
Many analysts recommend buying discount retailers because they tend to do well in a bad economy.
Others recommend gold related stocks which increase in value during periods of volatility.
A person could also invest in some foreign stocks for their growth potential and some for stability.
An investor might buy an Australian ETF because of that country's stable economy and a Brazilian ETF because of that nation's growth potential.
Inflation and Long Term Goals Many people invest in the stock market and stock based investments in order to compensate for inflation.
Traditionally value gains for stocks outpace inflation but this is not always true especially in periods of volatility.
Most diversification strategies are designed to enable investors to beat inflation and increase value.
An example of this would be to purchase a number of growth stocks, a number of foreign stocks and a number of historically stable American stocks.
Others may try to offset risks by purchasing indexed funds or ETFs which further diversify investment.
Many indexed funds invest in a large number of stocks for this purpose.
Diversify beyond the Stock Market It is also a good idea for investors particularly those investing for long term income to diversify beyond the stock market.
A good way to do this would be to purchase an insured investment such as an annuity that provides a long term guarantee of income.
Adding one or two good annuities to a portfolio is a great to compensate for stock market risk.