Why Diversify Your Stocks?
- Investing in mutual funds is one of the easiest ways to incorporate diversity into a stock portfolio. Mutual funds are professionally managed funds that purchase a variety of assets, such as stocks in different companies, bonds and other assets, often with a focus on a certain industry. By investing in a single mutual fund, your money will be diversified among all of that fund's holdings, which can be dozens of different investments. Due to their foundation in diversification, mutual funds prices tend to be more stable than individual stock prices, meaning that losses and gains will not be as large at the extremes. It is important to keep in mind that if a certain industry performs poorly, a mutual fund dealing with that industry will still suffer large losses, because all the stocks associated with that industry are likely to fall. Therefore, it is a good idea to spread investment capital across a few different mutual funds that have asset holdings in a wide variety of industries.
- Another way to diversity stock investments is to commit some capital to international stocks. Companies in developing nations often outperform those in well-established places such as the U.S. and European Union, and may not be affected as severely by the same political or economic factors. International investment protects against sudden economic hardships specific to a certain country. International investments can be made by investing in mutual funds that have asset holdings in foreign countries.
- Diversifying stocks is an important step to guard against risk, but diversification can go beyond simply splitting up stock investments between different companies or investing in mutual funds. A diversified portfolio cannot avoid stock losses when the market as a whole trends downward. Therefore, it is a good idea to commit a portion of your resources to investments outside the stock market, especially if you are older and have fewer years to invest. Investing in real estate and bonds are two common ways to further spread out assets. Government bonds are very safe investments that offer a modest but guaranteed return.
