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.