When it comes to investment strategies, you often hear the term diversification. It’s a fancy word used in the investment world, and means that you spread your money out into various investments rather than putting the money into one basket. Therefore, you put your money into various companies… not one! Don’t just invest in the U.S. stock market; invest in the international one as well.
By doing this, you attain two things:
- Reduce the investment risk, as you reduce the odds of losing money
- No reduction in the anticipated return, as the investments are expected to perform like if you hadn’t diversified
The only surefire way to do this is through diversification.
3 Primary Reasons Diversifications Works
- Individual investments, such as one company’s stock, is associated with an array of risk. After all, it could fail for any reason and without warning.
- The stock market has proven itself to be a worthwhile investment, and while individual businesses may fail, bigger companies withstand the fluctuations and succeed.
- Most professional investors don’t know what investments will succeed and fail, which is why they tend to underperform in the market.
With investment diversification, the investment is made in the whole stock market, not just one company. It allows you to make long-term returns without the risks associated with one company.
Why You Shouldn’t Diversify Your Investment Portfolio
There are many folks who are against the idea of portfolio diversification. The biggest argument made is that you won’t hit the jackpot when a company goes big with your investment spread among various companies.
Remember, an individual company can go belly up without warning, and the reverse is true of any company as well. They can make it big suddenly too. The more you have invested in it, the better off the return is going to be. This doesn’t happen if you’re operating under the diversification process.
According to the best investor of all times Warren Buffet, you should only invest into six ideas, which is the total opposite of what diversification is. Buffet said 99 percent of all people should do some extensive diversification. Why?
- Professional investors are not good at choosing winners and losers.
- Individual investors usually have lower returns than the whole market, usually due to chasing home runs.
It’s possible to put your money in one investment but you’re more likely to lose your shirt too. Diversification isn’t the best thing in the world but it’s one strategy that’s likely to lead to success.
What’s The Best Way To Diversify The Investments
If you’re going to diversify your investments, go with index funds. These are just mutual funds that follow a certain market. Index funds make it easy to diversify because the money is automatically spread out to various investments and at a low cost. Do the following:
- Determine your asset allocation – how many money to put into stocks and bonds.
- Look for investments that have index fund in their title.
You could find one mutual fund that works with an array of investments so that you can diversify your portfolio with just one investment. Diversification is easy to do, meaning you can get all the benefits associated with it with very little risk.