The Advantages of Diversification
Choose a mix of investments to lessen your risk
When you invest in a mix of different types of investments, you are diversifying. Diversification means lowering your risk potential by spreading money across and within different asset classes, such as stocks, bonds and cash. It's one of the best ways to weather market ups and downs and maintain the potential for growth.
Why diversification works
There’s no such thing as a sure thing. Different investments perform in different ways at different times, so it helps to own a variety.
You don’t want your portfolio to be dependent on the performance of any one investment. For example, if you own only one stock and it falls 20 percent, the value of your investments is down 20 percent. By adding in even one more stock that rises when the other one falls, it should improve your portfolio.
Ways to diversify
You can diversify you portfolio in three ways:
- Across asset classes with a long-term asset allocation plan that combines small-, mid- and large-cap U.S. stocks, international stocks, bonds, and cash.
- Within asset classes so you’re not too concentrated in any one market sector (e.g., technology or health care), company or country.
- By mixing investing styles through a combination of both value and growth stocks. This will help reduce the risks associated with investing strategies that perform better or worse in certain markets.
How much to diversify
While there are no hard and fast rules about how much to diversify, holding two or three stocks is probably not going to give you enough protection against market ups and downs. So how much is enough? Consider the following guidelines:
- For a well-diversified stock portfolio: 30–40 holdings in each of the broad categories of large-cap, small-cap and international stocks
- For a well-diversified bond portfolio: About $50,000 invested across various bonds
A stock or bond mutual fund can offer this type of broad diversification in a single investment.