GE is diversified, but it doesn't diversify your stocks

Q: Does General Electric stock ge add any benefit to a portfolio that already contains a collection of large U.S. stocks?

A: If you've been investing for a while, you've probably seen firsthand how diversification can be a big benefit.

When you put pieces of your portfolio into different types of investments, preferably pieces that don't move in lockstep with each other, your can lower your overall risk. That's one big reason investors typically put some money in stocks and some in bonds. It's also a reason why investors may be well served to put some of their money in stocks of foreign companies.

Since General Electric is involved in so many businesses, from aircraft engines to banking and appliances, you might think the stock would move in lockstep with large U.S. companies.

For that and other reasons, adding GE stock to a portfolio that already owns large U.S. stocks doesn't add much value on a risk-adjusted basis.

Here's why: First, it would be hard to have a diversified basket of large U.S. stocks that doesn't already include GE. GE is a member of the Standard & Poor's 500, the Dow Jones industrial average and the Russell 1000 indexes.

Also, if you factor in GE's dividend yield of 3.8%, GE's returns stay pretty close to the Standard & Poor's 500's. Last year, for instance, GE returned 3.4% after you add in the dividend yield, not far from the S&P 500's 5.5% total return.

That's not to say there aren't some years where GE and the S&P 500 part ways. In 2004, GE generated a return 21.6%, again adding in the 3.8% current dividend yield, versus the 10.9% return of the S&P 500.

But generally speaking, your hunch is correct: GE's stock moves closely to that of large U.S. stocks as a group. Using Excel, we learn GE and the S&P 500 have a correlation of 0.86. That means they're pretty closely tied together, considering that assets with a correlation of 1 move in lockstep and those with correlations of -1 move as a mirror image.

If you're willing to take on some extra risk, though, GE can potentially add some upside. A software program called MvoPlus from Efficient Solutions crunched market data back to 1963. It shows that in that period, GE's stock generated an average annual compound rate of return of 12.3%. That tops the 10.3% return of the S&P 500 during the same time. But you took on more risk with GE — 23.6 percentage points to be exact. That's well above the 16.0 percentage points of risk with the S&P 500.

So what does all this mean? If you put 10% of your portfolio in GE and the rest in the S&P 500, your expected return creeps up to 10.5%, according to the MvoPlus analysis. But your risk also rises, to 16.5 percentage points.

You'll need to find assets that are not so closely related to gain more of a diversification benefit.

Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Click here to see previous Ask Matt columns.

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