Diversify. Diversify. Diversify. Study investing and “diversification” ranks among the most common terms tossed around. Indeed, the first bit of advice many professional investors offer newbies is to diversify their investment portfolio. So what makes diversification such an important concept? Let’s dig in.
First, diversification means spreading your investments across different assets. This can mean many things. You might take your stock portfolio, then spread investments among various companies and industries. You might also diversify geographically, investing in Japanese, American and German firms.
You can also diversify your entire investment portfolio. Instead of putting your retirement savings in only stocks, you might purchase real estate, perhaps renting houses. You could also pick up precious metals, like gold or bonds paying interest. Less traditional assets, such as cryptocurrencies, might come into play as well.
So why should you diversify? As the old saying goes, you don’t want to put all your eggs in one basket. Drop that basket and you may lose all of your eggs. No breakfast for you, sorry. The same is true when investing. Everyone wants to invest in the next Apple. However, finding those diamonds in the rough is much easier said than done. For every Apple, there are countless Gateways, Nokias and Blackberries.
Outside of individual companies, macro-trends can create headwinds for entire industries. Ford put many horse carriage builders out of business and computers made typewriters obsolete. Trade wars might crush the value of foreign manufacturing firms, or housing markets could overheat, popping bubbles and destroying wealth.
Meanwhile, entire stock indices can suffer large dips while precious metals soar. By diversifying, you mitigate risks. If a company or even an industry suffers strong headwinds, only part of your investments may end up exposed.