Diversify Your Investments and don’t put them in One Basket

Most people would agree that putting all your proverbial eggs in one basket is convenient. It’s just one thing to keep track of and worry about. And yet if that basket falls – all your eggs may break. It’s no big deal if it’s just eggs we’re talking about but when considering all our savings and investments – it’s actually a matter of life and debt.

Diversification or ‘not putting all your eggs in one basket’ is an important but often overlooked concept. Diversification is simply the investment technique that reduces risk by spreading your investments around in various categories and risk levels to ultimately maximize your returns. It may involve short-term and long-term investment vehicles but is in the end a long-range strategy to minimize risk.

By diversifying in a wide variety of assets, investors reduce the upside and downside potential. This reduction of risk exposure will likely give investors a more consistent portfolio performance while economic conditions cycle through. So, some eggs may get broken along the way but others will not only be safe but increase in size.

What may confuse a lot of people is that diversification oftentimes involves putting your money into safe investment vehicles like bonds, CD’s, annuities or real-estate but also requires investing in more risky ventures like trading binary options (a financial derivative), Forex trading or the stock market. The idea is that some of your money will safely grow but to hedge against money-eroding inflation – investors need to take risks to leap ahead. Some of the money set aside for the riskier investments will be lost and some will hopefully multiply dramatically while your safer investments steadily keep chugging along.

Here’s a few examples. An investor has converted his savings to oil company stocks when stocks were climbing. However, the worldwide oil glut has sent energy stocks into a freefall. The investors’ portfolio will experience an obvious drop in value. If he counterbalanced the oil stocks, however, with a few transportation stocks like airline stocks, only part of his portfolio would be impacted. Of course, airlines will benefit with cheaper fuel and our investor would probably see a lucrative increase in airline stock prices.

Nevertheless, investors should diversify further into arenas and asset classes that are not correlated. Different types of companies, dissimilar industries and diverse types of investments altogether will reduce the effects of inevitable market swings.

Diversification won’t totally prevent losses, but it can reduce the impact or severity of losses and has the potential to hedge against losses. Of course, diversification doesn’t mean that once a portfolio is spread among different investments that one can count on this process and be less active. It may be the case in some instances that this works but the opposite may be truer. A diversified portfolio needs to be balanced and that also requires rebalancing at times, depending upon market conditions, reassessments, risk tolerance, etc.

In the end, it may be harder to track all of the separated eggs but the extra time spent checking up on different investments or exploring new opportunities is well worth the effort. Of course, earning more, losing less and perhaps retiring with a much bigger nest egg is the best reason of all to diversify.