What Is Diversification?

Learn about diversification in this Howcast finance video with expert Gregory McGraime.

Transcript

Diversification is the process of spreading your money in a lot of different investments so that you participate in the investments that are doing well and you limit yourself in the investments that aren't doing real well. So let me give you an example, I was working with somebody that worked for a large bank recently, and this woman was in her late fifties, she had $800,000 in her retirement savings and all of it was invested in her company's stock, so she just had one investment. Within six months that company stock went from $55.00 a share down to $5.00 a share. Her account went from $800,000 to under $50,000. Drastic, what can you do at that point? She can't afford to retire and she doesn't have a lot of options other than to continue working at this point. That could of all been avoided by proper diversification. And what I mean by that, if you invest in stocks, don't just invest in one stock, buy some large companies, buy small companies, buy international companies, so that if any one investment that you have does poorly, it's not going to infect your overall portfolio too significantly. When you invest in stocks, invest in different types of stocks, when you buy bonds, buy a lot of different types of bonds. Bonds from corporations, bonds from the government, short term bonds or long term bonds and having some cash investments can also help diversify your investments in general. A general rule of thumb is that you don't want to have more than 10% of your total portfolio in any one stock or any one industry or one type of investment, because if you do you are exposing yourself to too much risk.
And a lot of people are investing in a way that's very risky right now because they do have those concentrated positions. One way for the average person to diversify in a way that's much easier is to use mutual funds, because remember when a mutual funds invests your money for you; they usually buy a lot of different things all inside the one mutual fund. So sometimes with just a few funds you can get that total diversification that you're looking for to help balance out the return with the risk.

Popular Categories