The Advantages Of Diversifying Your Investment Portfolio

Any type of investing is somewhat of a gamble. Unless you are doing strict savings in a savings account (secured with insurance by the federal government up to $100,000 per individual for each institution), or you are buying secured savings bonds that you hold to full maturity, you are not guaranteed that your original principal (the amount of money you originally invested) is going to be protected.

That said, those types of investments usually produce a much lower return than do investments such as those you do in the stock market. Yes, of course, your principal is still somewhat at risk, and you can lose money. However, the key to making money with riskier investments such as the stock market is to diversify your investments. That way, you are almost certain to have some investments that will do well when others are not doing as well. In addition, you should also expect to diversify your portfolio among different types of investments. For example, your investment portfolio should generally be a mix of different kinds of investments, such as stocks, bonds, and short-term assets like CDs or money market funds.

If your employer offers a 401(k) and you take advantage of it, then you have some investments already. If you don't have a good idea of what your 401(k) is comprised of, you should take a look at it and perhaps talk with a financial adviser to see if it's diversified enough.

If your employer doesn't have a 401(k) or you are self-employed, then you're going to have to get started by investing on your own. One of the ways to get started as a new individual investor is to simply begin by investing in some mutual funds; if you earmark them for retirement in a traditional IRA, for example, you can invest tax-deferred, meaning that you pay now instead of later.

Mutual funds are a great way to buy many small "portions" of stocks without having to try to figure out which ones are going to do well or which ones are going to do poorly on your own. In addition, you can do something called "dollar cost averaging." This means that you set aside a certain amount of money every month, usually by automatic payment. This payment is taken out of your checking account every month and is used to buy shares in mutual funds. What you're doing with this small amount of money (whatever dollar amount you specify, oftentimes with an initial lump sum investment to open account) is to buy a portion of every stock in that family of stocks, so that you actually end up going a large number of stocks within that "family." This helps keep you diversified automatically, simply because you own a large amount of different stocks. Do some research to see what is out there, or contact a financial adviser to give you some ideas on what mutual funds are good to start with.

Diversification doesn't end there, though. Besides mutual funds, it's usually a good idea to buy some bonds and some and short-term investments such as CDs and money market funds as well. This is because you not only want to diversify within a certain asset class (in this case, mutual funds or stocks), but you also want to have other types of investments outside the stock market for further diversification. In general, if you have a long time until you're going to need your money (such as 20 to 30 years from retirement), you want to invest more heavily in stocks. If you have a relatively short time until you're going to need your money, you're likely going to want more conservative securities such as treasury bonds or fixed income mutual funds.

Depending on your situation, you'll need to distribute money among the different asset classes differently; even so, diversification is still important so that your investments as a whole are less at risk than they would be if they were not so diversified.