A dish that contains only one ingredient could taste rather bland and boring. Adding different spices and herbs to a recipe can make it more flavorful and satisfying. Similarly, a portfolio that contains only one investment type may not suit your financial goals. Choosing a variety of investments may result in a more satisfactory outcome.
Diversification* is the strategy of putting your money into several different investments. If you spread your money among different investments, you reduce your chance of suffering an overall loss if the value of one investment declines sharply.
Since the stock market is volatile, it’s likely that any stock investment you choose will decline in value at some point. Investing in a number of stocks helps diversify your portfolio.
Investing in one stock is a good start, but you’ll probably want to diversify your portfolio even further. Stocks of companies that are in the same industry or market sector may react similarly to market conditions. Choosing stocks that invest in different industries with different objectives and management philosophies may help provide diversification.
You can achieve even greater diversification by also investing in other types of assets, such as bonds and cash equivalent investments. The stock and bond markets often react differently to economic conditions. Bonds are generally less risky than stocks but have lower return potential. Cash equivalents are the least risky but have the lowest potential returns.
For smaller accounts or to gain exposure to a particular slice of the market (i.e., emerging markets, high yield bonds, commodities, etc.), adding mutual funds** to the mix may provide an even more effective way to spice things up and diversify. A mutual fund pools its investors’ money and uses it to buy a whole basket of different securities.
How should you divide up your investments among the different asset types? That depends on your risk tolerance and investment time frame. Your financial professional can help you diversify your investment portfolio to help you meet all your financial goals.
* Diversification does not ensure a profit or protect against loss in a declining market.
** You should consider the fund’s investment objectives, charges, expenses, and risks carefully before you invest. The fund’s prospectus, which can be obtained from your financial representative, contains this and other information about the fund. Read the prospectus carefully before you invest or send money. Shares, when redeemed, may be worth more or less than their original cost.
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