Investment Diversification

Investment diversification has long been one of the standard pieces of advice we hear from investment advisors.  It’s the age-old adage of “Don’t put all your eggs in one basket.”  It’s too easy to forget this principle during a booming stock market or real estate market, when everything is going up in value.  But given the collapse of stock prices and real estate prices in late 2008 and early 2009, it’s a good time to remind ourselves of the soundness of a strategy of investment diversification.

Even if you didn’t fall into the trap yourself, I’m sure you know people who lost a ton of money in the recent market collapse because they were too heavily invested in one area.  For example, people who were heavily invested in bank stocks took a beating.  The same is true of people who invested in real estate in Florida and other coastal areas.

I’m not suggested that investment diversification would have prevented losses during the recent market downturn.  The market declines were so broad-based that it was hard to avoid losses.  But those who were properly diversified minimized their losses and survived to fight another day.

So how do you go about having investment diversification?  Below, I have listed some simple guidelines to follow that will help you to diversify and “spread the risk” in your investments so you can minimize the potential of loss in the future.

1. Invest in Mutual Funds – Rather than investing in individual stocks and bonds, invest in mutual funds.  By their very nature, mutual funds diversify your investment over a large number of individual stocks and/or bonds.  That way, if one company in the fund goes bankrupt or suffers a severe decline in value, the effect on the fund as a whole is minimized, as is the effect on your total investment.

2. Invest in Different Types of Mutual Funds – Even though mutual funds create investment diversification by their nature, you can further diversify your investment portfolio by spreading your money among several different mutual funds.  Different funds have different investment objectives, so by spreading your money among different types of funds, you increase your diversification.  For example, you might put some of your money in a bond fund, some in a stock index fund, some in an aggressive growth fund, some in a blue chip fund, some in a balanced fund, etc.  It’s important to understand the investment strategies of each type of fund you invest in, so that you can be sure you are achieving the level of diversification you desire.

3. Invest in FDIC Insured Investments – While this sounds very boring, I think there’s something to be said for keeping a portion of your investment portfolio in FDIC insured bank accounts.  Whether it’s a certificate of deposit or an insured money market account, it’s a comforting feeling to know that a portion of your investments are backed by the U.S. Government.  Even in this day and time when our government is running massive budget deficits, having the full faith and credit of the United States guaranteeing your investment is something to think about.

No single investment strategy is appropriate for everyone, and I’m not trying to suggest a specific investment strategy or portfolio for you.  Your investments should be based on your personal financial situation and your investment objectives.  Still, the principle of investment diversification and spreading your risk is something you should keep in mind as you develop and monitor your investment portfolio.

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