What does diversification mean and why did my finance professors stress this word so much? I’m certain you have heard of diversity by now, as it is stressed in most every company. Well, diversity in your stock portfolio is extremely important too. Essentially, diversification means don’t put all your eggs in one basket. Now before you run off and claim you understand, let me further explain this important point: Diversification is just as important for the old as it is for the young. For example, just because you are young and wanting to take risks, you shouldn’t take all of the risks with one company or mutual fund or whatever your investment may entail, rather, spread those risks over several funds or investments. If I invest in one risky company, I could make a ton of money – however, I could lose it all too at any time. How can you combat that? Well, try investing in several different “risky” stocks, young buck.
You can accomplish this task by spreading your risks against multiple types of investments: Stocks, bonds, mutual funds, and money markets for example.
Furthermore, within the mutual fund field (for 401k investors) you have the ability to build a diversified portfolio of different types of funds; Such as value or growth funds, index funds, large and small cap funds and various other types of funds (I will later explain what these different types of funds are).
The key here is, if one is losing, chances are another will win – offsetting the chances of large losses.
Finally, diversify your security holdings by industries or geography. It is important to invest in several different types of companies across various regions to diversify your portfolio. If I were to show you a quick snapshot of my portfolio, you would see a portion of my assets are allocated across the world, to combat the falling dollar. International markets are a great way to combat local issues or currency problems. This was further evidenced in this past recession. In general, you should have around 25% of your portfolio allocated to international funds. Some people have a good argument in saying 25% is not enough, you need more exposure to international markets. Regardless, you should probably stay below 50% of your portfolio being invested in international funds.
Next up: Learn about how to make a retirement plan for yourself and family, and how to determine what your risk tolerance is and what approach you will need to take in investing. Determine how much money you will need for retirement.
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