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Diversification is Most Important Investing Rule

by Jeremy Holcombe

Diversification is hands-down the single most important rule when it comes to investing. Have you ever heard the saying “don’t put all your eggs into one basket?” The same thing goes for investing. You don’t want to put all your money in one place. Spread it around and let it grow.

Why Diversify Your Investments?

When you invest your portfolio, you have a number of different asset classes that you can consider — real estate, stocks, and bonds. Within those, you have more options. For example, you could invest in US stocks or European stocks; and with bonds, you may select corporate bonds or government ones. These are all options you should discuss about with your financial specialist, as they  offer good ways to diversify.

Consider this. If, in 2008, you had invested 100% of your portfolio into one asset class, US stocks, you wouldn’t have been very happy when your portfolio dropped 34% that year.

However, different asset classes often move in different directions at the same time. If you had diversified, and invested 50% of that portfolio in  US bonds (some government and some corporate), your losses would have been closer to 17.5%. While still not ideal, someone who was properly diversified during 2008 would have been considerably happier with his performance than someone who was not.

This is a tough example, as many people lost a ton of money in 2008 and have been losing since, but it drives home the point of how important diversification is.

Jim Cramer, host of “Mad Money” on CNBC, puts it very clearly when it comes to the importance of diversification.

“When you get too concentrated in one area, should something bad happen, you’re going to want to throw yourself off a bridge because the losses will be enormous.

“However, if your portfolio is properly diversified, then you can handle just about any setback. You can even come back from financial disaster.”

Diversification is of utmost importance to some of the brightest financial minds around. If you have all your eggs in one basket, then maybe it is time for you to make a few changes for the sake of your portfolio and your future.

Article Sources: CNBC | Yahoo Finance

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