Why should you diversify?
Diversification, or not putting all your eggs in one basket, is one of the basic principles of investing. Putting all your money in any single investment or asset class can be extremely risky. Because if your drop your basket of eggs, guess what happens: They all break. But by spreading your portfolio among multiple types of investments and asset classes, also known as diversifying, you can reduce the overall volatility in your portfolio.
How does diversification work?
Diversification works because different investments tend to behave in different ways over time; that is, some “zig” when others “zag.” For instance, the prices of stocks and bonds tend to move in opposite directions. When the stock prices fall, bond prices often rise, and vice versa. These opposite movements tend to lessen the impact of market volatility, creating a smoother ride for diversified investors.
A properly allocated portfolio of stocks and bonds helps with diversification, increasing your odds of investing success. For instance, this chart shows that a 60/40 portfolio (60% stocks and 40% bonds) would have resulted in an attractive risk (as represented by standard deviation) and reward (as represented by annualized returns) when compared to stocks or bonds alone.
Diversification helps you maximize your savings
Investment pioneer Sir John Templeton advised, “Diversify. In stocks and bonds, as in much else, there is safety in numbers.” Essentially, diversification is about spreading your money over different investments in a variety of asset classes, sectors, and geographic locations to reduce risk without sacrificing returns, and many investors find that ETFs are an excellent way to do this. When your eggs are diversified across several baskets, you won’t lose every egg if one basket drops. In fact, many eggs will keep on growing!