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Section Summary - Two
Course Section 2 - Lesson 5
Portfolio Components and Managing Risk
In section two, we familiarized ourselves with the type of investments you will see available to you in an online brokerage account.
Our primary focus was on stocks, but taking the time to learn about different securities like bonds, preferred stock, ETF's and mutual funds, helped us better grasp the investment landscape and understand where stocks fit into the greater investment universe.
We learned about the different rights afforded to the owners of a corporation's stock, and while some rights may never be exercised, the fact that they exist protects our investments and the future value we will derive from them.
We can sometimes fall into a psychological trap where we see stock investments as line items on a computer screen whose prices bounce around randomly. We must be vigilant about reminding ourselves our shares represent a real ownership interest in a company that has sales, employees and generates value for its customers. This knowledge will be our primary defense against acting irrationally during inevitable periods of price decline.
We also learned about the types of risks our investments will face: market, industry, and company-specific, and how we can protect ourselves against these unforeseen risks - through a process called diversification.
While diversification can't eliminate all of these risks, namely market risk, it does go a long way towards protecting us against industry and security-specific issues. Further, it's easy to implement a diversification strategy. By spreading our investments over about 20 companies, we defend ourselves against unforeseen events. In the likely case where we don't yet have 20 investment ideas, we can effectively diversify through position sizing and using passive index ETF's.
These first two lessons laid the groundwork necessary to begin searching and vetting investment ideas. In the following sections, we will be doing precisely that.