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Diversification
Let’s start with the analogy most everyone’s heard before: “Don’t put all your eggs in one basket”. Diversification is a strategy that can be used to help reduce the risk and volatility of your portfolio. A diversified stock portfolio will hold many, many stocks, rather than just a couple, or worse yet, just one stock.
We only have to look to Enron for an example of how diversification can benefit you as an investor. Unfortunately, there many ex-Enron employees whose retirement plans were invested largely, or completely in Enron stock. As you probably know, Enron stock is now nearly worthless.
The upside of diversification is clearly illustrated by this Enron example. Used properly, it can provide you with some level of insulation against the potentially dramatic swings in any one investment you own. What price do you pay for diversification? At the same time diversification is insulating you from your worst performers, it is also watering down the net results of your best performers.
How do you do it? One way to achieve good diversification is by using mutual funds. In addition to some other very strong benefits, the use of top quality mutual funds should provide you with all the diversification you’ll need.
Here’s something else to consider. Just as you can diversify by owning many stocks vs. just a few, you can also diversify among different types of investments. For instance, you may want a certain percentage of your money in stocks, another percentage in bonds, some in Real Estate, and some in CD’s, etc. Defining how much of your money you want to put into these different types of assets is a process called Asset Allocation.
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