Starting and Staying with a Diversified Investment Approach

The goal of diversification is to minimize risk. Instead of putting your eggs in one basket by investing every dime you have in one stock, one bond, or one mutual fund, you should diversify.

Diversification is a strategy for investing in a wide array of investments that ideally move slightly out of step with each other. For example, an investment in an international mutual fund might be doing poorly while an investment in a U.S. stock mutual fund is doing well. By investing in different sectors of the investment markets, you create a balanced portfolio. Parts of that portfolio should zig when other sections zag. Table 9-1 shows the power of diversification by examining how three different diversified portfolios of money markets, bonds, and stocks can fare over time. The table also give you a concrete idea of the investments that should go in a portfolio based on your own tolerance for risk. They’re also a good way for you to measure whether your own portfolio is diverse enough for your own tolerance for risk or loss. It’s important to determine the percentage of stocks, bonds, and cash you want in your portfolio. In the stock and bond categories (or mutual funds that invest in these assets), it’s also important not to load up on any one sector of the economy.

So steer clear of the temptation to invest in three technology mutual funds, four Internet stocks, or six junk bonds even if they’re paying more than other investments.
The saying “no pain, no gain” also applies to the investment experience. You can avoid the prospect of experiencing any pain at all by investing only in money markets and CDs that are federally insured. The price to be paid for that strategy:

You may never lose money in the traditional sense, but you never gain much either, which means that you can still fall behind. You also run the risk of falling behind because of inflation, which eat ups approximately 3% of your purchasing power each year. If you only earn 4% or 5% a year on your savings or investments, you’ll have a hard time preserving the capital you have, let alone growing it.