If you own just one or two investments, you probably spend a lot of time hoping fervently that they'll prosper. When they don't, it will be readily apparent to you — and to your portfolio's bottom line. Unfortunately, it's almost impossible to pick investments that will always perform well. And that's why you need to diversify.
By diversifying, you'll help yourself in several key ways. Here are a few to consider:
• You can help diminish the effects of "bad news." When you distribute your investment dollars among a wide variety of financial assets — stocks, bonds, money market accounts, government securities, etc. — you can help reduce the risk of being hurt by some "bad news" that hits a particular asset or asset class. For example, a series of unfavorable corporate earnings reports may well hurt stock prices. Yet, these same reports may have no effect on bond prices. So, if you own both stocks and bonds, the negative corporate earnings statements might harm you less than they would if you were solely invested in stocks.
• You can help increase your chances for success. At any given time, some types of financial assets will be doing well. You'll improve your chances of finding them if you cast a wide net and invest in a broad array of high-quality investments. Of course, it's still essential that these investments suit your individual needs, goals, risk tolerance and time horizon.
• You can help avoid some common investment mistakes. By following a diversification strategy, you may be able to avoid some widespread investment mistakes, such as chasing after "hot" stocks. If you don't concentrate on diversification, you may be more tempted to pursue those stocks whose price has gone up quickly. And yet, by the time you buy these stocks, they may already be cooling off. But if you're truly diversified, you may already have similar stocks in your portfolio, so you'll be far less likely to "chase performance" — which is almost always a bad idea.
As you can see, diversification offers you some major benefits. And the longer you invest, the more possibilities for diversification you'll discover. You'll find that you're not limited to diversifying across a range of investments — you also can diversify within each individual investment category.
To illustrate this point, let's consider just one asset class: stocks. You could include a lot of stocks in your portfolio — but they could all be the same type of stock. It's not at all unusual to find people who "load up" on one species of stock, figuring that if one is good, more is better. If you're going to be diversified, though, you'll need to look at the full range of stocks: blue chips, international stocks, small-capitalization growth stocks, value stocks, etc.
When it comes to investing, it pays to be as broad-minded as possible. So, spread your dollars among a variety of suitable, high-quality investments. You should be pleased with the results.