Whatever Happened to Diversification?

Posted March 4, 2009 by Bernz

Every investor has heard the advice to diversify their portfolio holdings in order to reduce risk and increase income. It is the gospel of every television financial guru and appears in every brokerage newsletter.

diversification

But how many people actually know what it means and practice it on a regular basis? Diversification is nothing more than a variation of the old “don’t put your eggs in one basket” mantra that has served people well from the Great Depression until today. Spreading out your investments amongst different industries, securities types and company size protects you from an economic downturn in any one segment of the market.

While diversification makes logical sense, many small investors choose to ignore the safe route and try to make fast money in the markets. It’s easy to see why people choose this path. Every late night “you too can make a million next year with tax notes” charlatan encourages you to forget about boring bonds and blue chip stocks and get on the train to riches. After all, Joe from New Jersey made $120,000 last month by spending five minutes a day picking stocks. Regardless of how tempting this mythical easy money is, diversification is even more important in today’s economy. Many industries are hurting financially and their stocks are down significantly. A well-diversified portfolio can handle this. This kind of portfolio will hold some recession-proof stocks that will even out the risk and will still provide an income.

Diversification is also an issue for those who don’t even own investment portfolios. Amongst the working class, home equity is often the most important or even only investment asset owned. That makes home ownership a risky proposition when home values go south. A more balanced approach of real estate, bonds and equities would be more sound in today’s markets.

The age-old principles of diversification are just as relevant today as they were 80 years ago. Putting all of your eggs in one basket will only run the risk of getting them all broken.


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