Diversification1 involves spreading your investment dollars within and/or among the three main asset categories, which are stocks, bonds, and cash. The reason financial professionals encourage you to think seriously about diversification is because of its potential to help protect the overall value of your portfolio against losses.
Here's how it works: Gains in one area of a diversified portfolio could offset losses elsewhere and may even help increase your overall investment value in spite of those losses. Because the stock market's top-performing investments have often changed from one year to the next, diversification may be a particularly effective way of managing risk over the long term.
Simply put, mixing up your portfolio with complementary investments may potentially improve your chances of earning positive returns regardless of short-term market trends and fluctuations in the stock and bond markets.
For many investors, the most convenient and efficient way to diversify is to invest in mutual funds. Mutual funds are professionally managed and typically invest in many different securities at the same time. As a result, you may be able to construct a well-diversified portfolio by investing in just a few mutual funds. Likewise, more sophisticated investors can create a diversified portfolio of stocks, bonds, and cash with the help of a qualified financial professional.
For more detailed information, see our saving and investing goal page.
1Diversification does not assure a profit or protect against a loss.
GE 91145 (01/2016)