Investment Diversification: What It Is, Why It Matters, and Tips to Attain It

Diversification is spreading your investment money among different types of investments. This long-term investment strategy reduces risk without sacrificing potential returns.

Not putting or keeping too much money in one investment or investment type helps provide more consistent potential returns. If one investment performs poorly, others might perform well, potentially offsetting any losses.

Benefits of Investment Diversification

Investment diversification offers the following benefits:

Reduced Risk

Investing your money in different assets and asset classes means there is no single point of failure for your portfolio. That investment or group of investments makes up only a portion of your total investments. Therefore, if one company or industry experiences a difficult time, the impact on your portfolio will be cushioned.

Smoother potential returns

Diversification increases the likelihood that at any given time, some parts of your portfolio will perform better than others:

• Although stocks and bonds historically provided positive returns over long periods, it is difficult to predict how any individual stock or bond will perform in the near term.

• All investments can hit occasional bumps.

• Individual investments tend to lead and lag at different times.

Support with Maintaining an Investment Plan

Diversification encourages you to maintain your long-term investment plan. Reducing portfolio bumps provides confidence that your money is properly invested. As a result, you are less likely to sell investments when the market is down, reducing your portfolio’s value.

Diversification Across Asset Classes

Consider diversification across asset classes, the major investment categories, such as stocks and bonds. Your asset allocation, or how you divide your money between stocks and bonds, should be based on the following:

• Investment goals

• Time horizon

• Financial situation

• Risk tolerance

Diversification Within Asset Classes

Consider holding a variety of investments within each asset class:

• Choose your investments based on your objectives and situation.

• Change how your portfolio is invested based on your life changes, such as marriage, starting a family, divorce, and retirement.

• Regularly review your portfolio to ensure it is consistent with your goals.

Investment diversification includes the following: 

Stocks

• Geographic exposure: Owning US and some international stocks with different exposures to specific regions and countries.

• Company size: Holding some shares of small, medium, and large companies, called large, mid, and small caps.

• Stock style: Holding stock from high-growth-potential companies and undervalued companies, called growth and value stocks.

• Sector and industry: Owning different parts of the stock market, such as technology, energy, and health care.

Bonds

• Issuer type: Owning some bonds issued by the US government, government entities, or corporations.

• Maturity date: Holding some bonds that come due in the next few years, and some that come due in a decade or longer.

• Company attributes: Purchasing corporate bonds from different types of companies.

• Credit rating: Holding some bonds from highly rated issuers, which typically pay less interest, and a few from riskier issuers, which typically pay more.

• Bond structure: Owning bonds that vary in structure and attributes, such as inflation-protected, convertible, callable, and zero-coupon.

Tips to Diversify Your Portfolio

These tips can help you diversify your portfolio:

1.  Research and select a mix of stocks and bonds. Use stock and bond research tools to choose your investments.

2.  Invest in mutual funds and exchange-traded funds. Mutual funds and EFTs are made of diverse investments.

3.  Work with a licensed financial professional. A licensed financial professional has the knowledge, tools, and experience to diversify your portfolio.

*This information is for educational purposes only.

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