Investing Unit 2: Diversification


You can do several things to offset the impact of some types of risk. Diversifying your investment portfolio by selecting a variety of securities is one frequently used strategy. Done properly, diversification can reduce about 70% of the total risk of investing. Think about it. If you put all of your money in one place, your return will depend solely on the performance of that one investment. Alternatively, if you invest in several assets, your return will depend on an average of your various investment returns. Here are three basic ways to diversify your investments:

  • By choosing securities from a variety of asset classes, e.g. a mix of stocks, bonds, cash, and real estate
  • By choosing a variety of securities or funds within one asset class, e.g. stocks from large, medium, small, and international companies in different industries
  • By choosing a variety of maturity dates for fixed-income (bond) investments.

By diversifying, you won’t lose as much as if you invested in just one security right before its market value goes down. However, if the market goes straight up from the time you started, you won’t make as much in a diversified portfolio either. However, historically, most people are concerned about protection from dramatic losses.