Diversification

An investing strategy that seeks to minimize risk by diversifying among many types of investments. Diversification and risk are directly related to each other because the more you diversify your portfolio, the less risk you have.

To illustrate, say all of your money was wrapped up in the stock of one particular company -- XYZ Corp., the largest widget maker in the world. This would be a risky proposition for three main reasons. First, the value of XYZ's stock could be adversely effected by weakness in the overall stock market. Second, the value of the stock could suffer if the widget industry as a whole falls onto hard times. And finally, even if both the stock market and the industry are doing great, the value of XYZ Corp.'s stock could tumble for a variety of other reasons unique to the company such as an unexpected shutdown of its plants, the loss of a key customer, or even the death of one of its key executives.

If you instead had a little of your money in XYZ Corp.'s stock, a little money in a diversified mutual fund that owns several stocks, a little money in bonds and a little in real estate, the chances of your portfolio plunging suddenly would be greatly reduced.

Of course, you probably already learned this lesson when your mother told you, "Never put all your eggs in one basket."

 

 

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