Have you ever heard the saying that you shouldn’t put all your eggs in one basket? The problem, of course, is if that basket falls, all your eggs will go with it. Well, the same advice applies to investing—except replace the eggs with your hard-earned dollars.
If you invested all of your money in a tech stock and the company went bust, for example, all of your money could go with it. Even if you spread your money across several companies in one sector, your portfolio could get dragged down if that sector sinks.
But invest your money in a range of sectors like tech, health care, consumer goods, financial services and oil and gas, as well as in companies located in different countries, and the portfolio is diversified. Even if one industry—or one country’s economy—fails, you still have other investments to keep you afloat.
So what’s the best way to diversify?
Determining exactly how to diversify your portfolio depends on your investing timeframe, goals and the level of risk you can tolerate.
But you can lower your risk exposure by investing in a mix of stocks (which can offer greater returns but come with more risk) and bonds, which are typically less risky but also less rewarding. You can further diversify by investing in small and large U.S. and international companies and real estate stocks, for example, and in U.S. and global corporate and government bonds, says Kimberly Foss, Certified Financial Planner and founder of Empyrion Wealth Management.
Can a diversified portfolio still go down?
Well, investing in the markets always carries some risk, even when you diversify. But spreading your money across a mix of investments can lower the risk of your portfolio being dragged down when one company, sector or country is struggling.
Of course, there are rare times when various industries or markets crash at the same time—like in 2008 and 2009—which can be unsettling. During times like those, it’s good to remember that, historically, the stock market has recovered from even the deepest downturns and continued to climb over time. So it pays to be patient, too.