Diversification can be done in many ways, which we’ll get to in a moment. But the most important part of having diversified investments is that it provides some protection for your portfolio.
If you put all your eggs in one basket and that basket gets knocked off the table, all your eggs will break. If you had put only half your eggs in that basket and put the other half in a carton in the refrigerator and the basket fell off the table, you’d still have half your eggs safe in the fridge.
It’s the same thing for your investments. If you invest solely in stocks and the market tanks, you could lose everything. Diversification means that any catastrophic loss in one area won’t wipe out all your investment holdings.
These are a few types of asset diversification:
- Spread your investment accross different asset types (stocks, bonds, commodities). You can also diversify even within one asset type, for instance, buy different companies’ stocks
- Asset Allocation: You can use an asset allocation fund that uses a predetermined percentage of stocks and bonds. For example, a 60/40 fund invests 60% in stocks and 40% in bonds.
- Invest in a mix of ETFs and mutual funds: ETFs and mutual funds are generally more diverse than buying one or two stocks.
- Invest in foreign companies and assets: While the United States is the biggest country in terms of market capitalization, global companies play an essential role in the markets. And it’s good to have some exposure to other markets.
- Vary your investment by company size:In addition to investing in different assets, you should also invest in different company sizes and types. You could do this by buying a mix of stocks from bigger companies, as well as a few lesser-known companies. You can also hold stock in different industries, such as health care, energy, or retailers.