A Valuable Lesson About Portfolio Diversification

Editor's note: Ally Bank was once a part of GM, not GE.

A successful company is one that is able to adapt to ever-changing market conditions.

Companies that specialized too heavily in one area are likely to have problems if they can't pivot fast enough. For example, companies that focused on taxi medallion financing without diversifying their offerings have faced or will face trouble with the rise of companies like Uber and Lyft -- companies that have apparently discovered the formula of reducing overhead and providing convenient and discounted transport service to consumers.

One way to ensure long-term success, or at least to make the odds better, is to have diverse product offerings. That way, even if one part of the business is failing in the market, the company as a whole is able to stay afloat. You also want to look for companies that have survived adverse business cycles before. Although it's no guarantee of future success, it provides a fairly good indication of a company's ability to adapt.

A full transcript follows the video.

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This podcast was recorded on Dec. 7, 2015.

Gaby Lapera: Medallion thought it was on top of the world back in 2011, and then something came along that no one expected in the form of the tech innovation. And this is going to keep happening more and more as the pace of the technology industry accelerates.

This is a reality that could happen to any company. But there are some things that you as an investor can do to help insulate yourself from these kinds of risks. And I know we harp on this a lot on this podcast, but diversity is critical to every portfolio -- both having a wide variety of companies as well as having companies that offer a wide variety of products. So even if one business segment bites the dust, they still have other ways of keeping themselves going.

John Maxfield: Yeah. And that the critic...really, really critical thing because you have to match up what Gaby's saying about, you know, there are these industries, and you can think that an industry is completely protected from competitors because there's nobody else there, there's nobody else providing those services. But then some sort of technological innovation will come along and completely decimate or completely disrupt an industry.

Back when, in the early 1900s, when you had cars come out. For the longest time, nobody thought that automobiles were going to be, they thought it was just going to be kind of a niche hobby market. But then it came out and totally disrupted horse and buggy market. And it was just completely unseen.

So, it's important for investors, the one way to protect yourself from this, because you can invest in a good company for 30 years, and it can be a good decision, and they could get disrupted in 15 years.

The best way to protect yourself is just diversifying, and you can do that by either buying just a bunch of individual stocks, or probably the easiest way, and probably the most sure way to diversify your portfolio adequately, is just to buy an exchange traded fund and invest in, say, the S&P 500.

Lapera: Absolutely. And then like I was saying about companies that have diverse business lines. You have, say, for example, GE , right? They have energy, aviation, healthcare, transportation, they even had GE Financial for a while, which they're spinning off and selling off to different people. But they basically ran a bank. I don't think a lot of people knew that GE essentially had a bank within itself for a really long time. It wasn't doing great, so now they're selling it off.

Maxfield: And it was a huge bank.

Lapera: It's a huge bank.

Maxfield: I think in asset sizes and they run off some of their assets, and this has since been sold off, and I think it operates under the name Ally Bank now, right? That used to be GE's if I'm correct. And it's a huge bank. I think it's a top 10.

Lapera: Oh yeah, absolutely. But when people think GE, they don't think about that; they think about like washing machines. They definitely don't think about them making airplane stuff either, you know? But they have a lot of different things.

Another one is like a Procter & Gamble or a Johnson & Johnson . They just have so many different business lines that people don't even think about. Johnson & Johnson, for example, makes surgical instruments. A lot of people have no idea. They just think of them in terms of Band-Aids.

Maxfield: Yeah, yeah. And so you know, you're looking at Procter & Gamble or Johnson, I mean these are your definitional companies that have internally diversified their product lines. And say if you're looking at a company that's focusing exclusively on medallions, or over-focusing on them, you really can see the impact of not diversifying because of what that will do to your revenue stream.

Or as opposed to your companies that Gaby was just talking about, you can have one business go down, other businesses will pick up the slack.

Lapera: Absolutely. The other thing you want to look at, and something all these really big businesses have done, is that they have weathered adverse business cycles where innovation or bad market conditions could've killed them, but they didn't. So that means you're going to be looking for companies that are highly adaptive and able to pivot to meet new challenges or environments.

The business that comes to mind for me, because we do financials, is actually Community Bank System . They're a small bank system that's up in New York, and they actually thrived during the financial crisis because what they did was -- a lot of the bigger banks, they pulled out of the really small towns there because it was hard for them to be profitable there -- and Community Bank System just swept up, scooped up all those little banks, all those little small towns, because those people still had to bank, and there was no one to fill that void. And now bigger banks are having a hard time moving back into those small towns because everyone is with Community Bank System. Pretty smart.

Maxfield: Yeah. That's smart. You know Gaby, I've not looked into that company. I'm going to have to take a look at that.

Lapera: Oh yeah, absolutely. We can talk about it one day. It will be pretty exciting.

The article A Valuable Lesson About Portfolio Diversification originally appeared on

Gaby Lapera has no position in any stocks mentioned. John Maxfield has no position in any stocks mentioned. The Motley Fool owns shares of General Electric Company. The Motley Fool recommends Johnson & Johnson and Procter & Gamble. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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