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What does It Mean to Diversify Your Funds?
Tricia Christensen
Tricia Christensen
Most people who invest are advised to diversify funds. This means taking one’s total investments and dividing them into different groups. Overall the goals hoped for when people diversify funds are that they will have both risk and profit shared among a large group of investments. In general investment profiles that diversify funds have lower but more predictable returns.
The old adage “Don’t keep all your eggs in one basket,” applies to the fundamental principals of investment. If one invests in only one mutual fund, stock or company, a loss means that the sole investment can be lost. However when people diversify funds, a loss in one area may be made up for by gains in other areas. Thus all the “eggs” or in other words, investment, are not lost.
Generally when people diversify funds, they invest in three separate areas. A portion of the portfolio might include the purchase and ownership of stocks, bonds and short-term investments. Risk when people diversify funds depends in part on what percentage of money is invested in each area.
Financial advisors often recommend a higher risk profile for younger investors, and a lower risk profile for investors who are older and would be greatly affected by loss of funds. Stocks are considered the highest risk investment, so the person ventures a greater risk with a higher percentage of money invested in stocks. Stocks also represent, in many cases, the highest chance of return. Risk must be weighed against benefits.
Investment in bonds is usually a part of the way people reduce their risk when they diversify funds. Bonds have less ups and downs, though are also less likely to reap huge benefits. They can offset investment in stocks however, so that not all money is lost and some money invested in bonds can be expected to make a reasonable and fairly predictable return.
Short-term investments, like money market funds are the least risky of investments. They also provide people with access to their money right away, which is not the case in the longer-term investments into bonds and stocks. With the least risk in profiles that diversify funds, also comes least return. Money deposited in a savings account in a bank, for instance, is likely to make minimal income. Yet this money is relatively safe, especially as compared to money invested in stocks.
Those who get a late start in investing, and still wish to retire on a reasonable income often diversify funds with a larger share going to risk. Those who have a reasonable amount of money for retirement tend to diversify funds among bonds or short-term investments.
Tricia Christensen
Tricia has a Literature degree from Sonoma State University and has been a frequent WiseGEEK contributor for many years. She is especially passionate about reading and writing, although her other interests include medicine, art, film, history, politics, ethics, and religion. Tricia lives in Northern California and is currently working on her first novel.
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Tricia Christensen
Tricia has a Literature degree from Sonoma State University and has been a frequent WiseGEEK contributor for many years. She is especially passionate about reading and writing, although her other interests include medicine, art, film, history, politics, ethics, and religion. Tricia lives in Northern California and is currently working on her first novel.
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Discussion Comments
"Don't keep all your eggs in one basket" is a great phrase and it's the best advice when it comes to investing funds. I think of intelligent fund diversification as a form of insurance. It helps limit loss while encouraging profits.
The world of investment is a rather unpredictable one. And as much as people would like to believe that they can predict it or make wise investments, there is always the risk that things will not work out. Diversification is one of the best ways to make sure that everything is not lost. The additional, diverse investments are like back-up.
@fBoyle-- That's a good question.
People may have up to thirty separate investments. But they're not all in separate forms. For example, ten may be in stocks, ten in bonds and the rest in others. But this doesn't mean that people should diversify as much as possible. It is possible to over-diversify, which is bad.
Generally, investors are encouraged not to have more than thirty investments and not to have too many investments in one form. Diversification reduces risk, but after a certain point, it starts increasing risk. Thirty investments is believed to be that point, but I think it may be less than that.
Each investor should be consulting with an expert in this field to make sure that they are diversifying correctly
I've heard of people having twenty or thirty separate investments. I know that it's good to diversify investment, but isn't this a little too much? Does diversification always mean lower risk?
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