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Investing Basics, Diversification
What does it mean to be diversified?
There is truly no exact definition for this, but basically, it means do not put all your eggs in one basket.
A pretty good definition of diversification is given on Nasdaq.com. It states diversification is, “Investing in different asset classes and in securities of many issuers in an attempt to reduce overall investment risk and to avoid damaging a portfolio’s performance by the poor performance of a single security, industry, (or country).
So let’s break this down. First, what are asset classes?
An asset class is a group of securities that exhibit similar characteristics, behave similarly in the marketplace and is subject to the same laws and regulations. Three common asset classes are stocks; bonds; and cash equivalents (like money market funds).
There are many other types of asset classes such as real estate, precious metals, commodities, etc. But the main idea to learn here is that diversification into different asset classes might make your portfolio less volatile.
Next, diversification means to own more than one security within each asset class. For example, you might want to own several stocks, or several bonds instead of just owning one stock or one bond.
The reason is pretty simple. If you only own one stock your risk is higher than if you own many stocks. Let’s say that the one company you own goes bankrupt, you could possibly lose all the money you had invested in it. But if you had many stocks, then even if one company goes broke, it will not affect your portfolio nearly as much.
Same thing with bonds. If you own just one company’s bond or just one city’s bond and that entity goes broke, you will probably not be able to get your principle back.
You can be well diversified by owning a mutual fund, but even then, it might be a good idea to own more than one fund in different asset classes.
Exactly what your mix of stocks, bonds, funds etc. will be is determined by many factors such as your age, your risk tolerance, your objective etc.
Is there anything wrong with being less diversified?
Not necessarily, as long as it makes sense for your particular situation and you understand the risk. Just remember that the fewer securities you own, the greater the risk.
Asset allocation and diversification is something that a good financial planner should be able to help you with. In our next exciting edition of “Investing Basics for Savvy Women,” Savvy Women’s own Catherine Magana, who is a CFP, (a Certified Financial Planner), will explain what a CFP can do for you.
Until then, Savvy Up!!
Steve Wolff is a Managing Partner at WWM Financial in Carlsbad California.
We run a Savvy Women Wealth Practice in Carlsbad, California offering financial planning and investment advice. Most of our clients are fun, engaging women who are driven to succeed both personally and professionally. They have spent most of their lives focusing on others and realize they must take more responsibility in their financial future. They don’t want to simply be told what to do they want to learn, become more engaged and accountable for their financial future.
Steve can be reached at 760-692-5700 or click on the following link to contact us directly https://savvyup.com/contact .
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