Understanding Diversification

Key Takeaway

A widely diversified portfolio may help cushion investment risk by reducing the impact of poor performance in any one investment or industry. No single fund can do it all, so consider investing in several funds with different investment objectives.

What Is Diversification?

Diversification is the strategy of putting your money into several different investments by limiting your exposure to any one type of asset. Over time, this practice can help balance risk and reward in your portfolio.

Benefits of Diversification

Diversifying into different types of investments helps reduce your overall risk because when one type of security falls, another type may rise.

Your portfolio’s asset allocation should reflect your risk tolerance and investing time frame. Beyond that, diversifying your portfolio can help you reach your investment goals by better preparing you for the uncertainties of market performance. The value of diversification may reveal itself only over time, so it’s important to be patient.

Funds Selection

The selection of appropriate funds for your portfolio depends on your risk tolerance and time frame until retirement. Different asset classes often respond differently to similar market conditions, so investing in a mix of stock, fixed income, and cash investments is the first step in creating a diversified portfolio.

Investing across all three major asset classes reduces the possibility that a decline in any single investment or asset type will put your entire investment portfolio in jeopardy. For example, having fixed income and cash investments may help moderate your losses if the stock market suffers a decline.

Of the three major asset classes, (stocks, bonds, and cash alternatives) stocks generally provide the best potential for long-term growth and returns that outpace inflation. However, stocks also have the highest potential for losses.

Bonds typically offer lower returns than stocks, but they have less risk of loss. Bond prices may also fluctuate due to interest rate changes. And while there’s little risk of loss with cash alternatives, it is possible to lose money investing in them.

You’ll also want to diversify within each investment type. Holding a variety of small-, mid-, and large-cap stocks and investment-grade bonds with varying maturity dates may help reduce your risk.

Tools and Guidance

Take the Alerus Investor Questionnaire. This quiz helps to measure your tolerance for investment risk and suggests investment strategies that can be applied to the fund in your plan.

Seek additional help from a Certified Financial Planner or other investment professional.

Diversification does not ensure a profit or protect against loss in a declining market.