The Benefits of Diversification

How many times have you heard someone say, "Don't put all your eggs in one basket"? When it comes to investing, that's very good advice.

Successful investors know that diversifying their investments can help reduce the impact that a single, poorly performing investment can make on their overall portfolio, or mix of investments.

Diversification means having different kinds of investments, such as stocks, bonds, and mutual funds. It also means having a mix of investments in different sectors or industries. A well-diversified portfolio might include bonds, money market funds, and stocks of small, medium, and large companies in a variety of industries and countries. International stocks, for example, may rise at the same time domestic stocks are falling, softening the blow to your overall portfolio. Even if your risk tolerance is low, you can still consider diversifying into riskier investments as long as you keep the overall risk of your portfolio low.

Determining Your Investment Mix

An important first step in building a well-diversified investment portfolio is deciding how to divide your money among various investments - a process called asset allocation. These types of investments can include individual stocks and bonds, mutual funds that invest in stocks or bonds, or bank accounts or money market mutual funds.

Financial professionals such as stockbrokers, financial planners, or insurance agents can help you analyze your financial needs and objectives and recommend a mix of appropriate investments. In addition, mutual fund organizations may use their own sales forces or outside professionals to help potential investors. If you prefer to do it yourself, researching stocks and mutual funds and buying shares can be accomplished through the mail, over the telephone, or on the Internet. It's not as complicated as you might think.

To help you determine the mix of investment options that may be appropriate for your investment goals, ask yourself the following questions:

What are my investment goals?
How much time do I have to reach these goals?
How much can I afford to invest regularly?
How much do my assets need to grow to reach my goals?
How much investment risk am I willing to take to reach my goals?

Diversification is essential for successful investors who have multiple goals with different time horizons. For example, a 30-year-old unmarried investor is likely to need a different investment mix than a 50-year-old with two children heading off to college in the next few years. If you are retired, protecting your principal becomes increasingly important as opposed to growing your investments.

An aggressive asset allocation is most suitable for investors with a long-term investment horizon (for example, 20 years or longer), who tolerate risk well, and whose primary goal is growing their investments.

A moderate asset allocation is most suitable for investors with a medium-term investment horizon (for example, 10 years or longer), who tolerate risk moderately well, and whose primary investment goal is a moderate level of growth.

A conservative asset allocation is most suitable for investors with a short-term investment horizon (for example, less than 10 years), whose risk tolerance is low, and whose primary investment goals are generating income and protecting against inflation.

These pie charts represent sample asset allocations. They should not be interpreted as investment advice. Your own allocation decisions must take into account your individual circumstances. And, as your circumstances change, your allocation decisions should be reviewed - and adjusted - as needed.

Maintaining a Diversified Portfolio

It's a good idea to periodically review your investment plan. Because different investments grow at different rates, your original allocation of money among stocks, bonds, and mutual funds will change over time. If this happens with your investments, you will probably need to redistribute some money to bring your investment mix back into line with your original plan.

In addition to the annual review, whenever you make a major life change, it's time to reassess your overall financial situation. Some common examples of such changes include switching careers, retiring, getting married or divorced, having a child, starting your own business, taking care of an elderly parent, and returning to school or paying tuition for a child. Most of these events are likely to affect your ability to invest, your time horizon, and your investment goals, both short-term and long-term.

It's never easy to find the time to review your investment plan when you're in the midst of any of these life changes. But it's worth making the effort. You don't want to enter a new phase of your life with a financial plan that was designed for different circumstances.

In the end, staying on course with a diversified investment mix will help make sure that the performance and risk levels of your overall portfolio reflect your goals and expectations.