The Importance of DiversificationIf 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.
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 will gain.
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 companies. Perhaps you can add international stocks or bonds.
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 manage risk in your portfolio. Bond funds are usually more conservative, but they can be a good tool to balance a portfolio and possibly protect it from serious harm.
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, changes in interest rates, and general market and economic conditions. 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.