The Importance of Diversification
If ever there was a hackneyed investment cliché to remember and use again
and again, it is to avoid putting all your eggs in one basket.
Any investment can be considered a risk. Every investment is subject to unexpected
changes. Nothing is completely safe. If you're narrowly invested in one stock
or one sector, an unforeseen hit could be difficult to withstand. But if your
investment eggs are spread around, in diverse baskets of different styles and
characteristics, then the risk against inevitable change is reduced.
"If you want to manage portfolio volatility" says
Tom Biwer, an investment manager with the Wells Fargo Advisor program, "then
following that old cliché about not having all your eggs in a single
basket is a good idea."
Investing in a mutual fund provides diversification among stocks, because funds
can hold shares of hundreds of different companies. But at the same time, mutual
funds generally target a specific investment style (growth or value, large companies
or small, technology or utilities).
The market is cyclical. The duration, intensity and frequency of market changes
are hard to predict. Some sectors of the market will do well while others falter.
For example, technology stocks could do well at a time when utility stocks suffer.
Small stocks might flourish while large stocks stumble. Then those sectors could
flip-flop suddenly. The once-strong sector will fall and the once-poor sector
The smart choice for most investors is to choose several different types of
mutual funds. You could select one fund that invests in big companies and another
in small; a fund that invests in fast-growing, innovative companies and another
in more established, rock-solid companies. Perhaps you can add international
stocks or bonds.
"Shifts in the market can be sudden, dramatic, and sharp,"
Biwer says. "And you never know which style of investment or what sector
will dominate or outperform in the future. So it's better to be exposed to all
styles and many sectors."
Find an investment balance that works for your long-term goals and ride out
the inevitable rises and declines in the market. Consider growth funds, which
are mutual funds that may have greater short-term volatility but offer the potential
for higher returns in the long run. Or consider value funds, sort of a bargain-hunter's
fund, investing in companies that the manager views as undervalued.
Investing in various sectors of the market is another good way to diversify.
For example, if you include investments in such sectors as technology, utilities,
consumer staples, capital equipment, and energy, the dips in one area might
be offset by increases in another.
And consider bond funds as another way to help manage the
blows of a tumultuous or rickety market. Bond funds are usually more conservative,
but they can be a good tool to balance a portfolio and possibly protect it from
The key to diversifying is variety, done with imagination, reason and commitment
to long-term goals.
Stock funds should only be considered for long-term goals as values fluctuate
in response to the activities of individual companies and general market and economic
conditions. Bond fund values fluctuate in response to the financial condition
of individual issuers, general market and economic conditions, and changes in
interest rates. In general, when interest rates rise, bond fund values fall and
investors may lose principal value. Some funds, including non-diversified funds
and funds investing in international securities, high yield bonds, small- and
mid-cap stocks and/or more volatile segments of the economy, entail additional
risk and may not be appropriate for all investors. Consult a Fund's prospectus
for additional information on these and other risks.