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Investing is one of the best ways to build wealth and reach your long-term financial goals. But what should you invest in? While there’s no one right answer for everyone, there is one principle that can help guide your investing decisions: diversification.
“No matter what your goal is, diversification is a key to investing,” says Corbin Blackwell, a senior financial planner with Betterment.
As with many things in the world of finance, diversification seems complicated at first. But we’ve spoken with two investing experts to help break down what exactly diversification means, how diversified your portfolio should be, and how to start diversifying your portfolio right now, even with a small amount of money.
What Does it Mean to Diversify Your Portfolio?
When you diversify your portfolio, you incorporate a variety of different asset types into your portfolio. Diversification can help reduce your portfolio’s risk so that one asset or asset class’s performance doesn’t affect your entire portfolio.
There are two ways to diversify your portfolio: across asset classes and within asset classes. When you diversify across asset classes, you spread your investments across multiple types of assets. For example, rather than investing in only stocks, you might also invest in bonds, real estate, and more.
When you diversify within an asset class, you spread your investments across many investments within a certain type of asset. For example, rather than buying stock in a single company, you would buy stock from many companies of many different sizes and sectors.
Why Is It Important to Diversify
The primary goal of diversification is to spread out your risk so that the performance of one investment doesn’t necessarily correlate to the performance of your entire portfolio.
“Remember the old saying, ‘you don’t want to put all your eggs in one basket?’” says Delyanne Barros, an investing expert and the founder of Delyanne the Money Coach. “Now imagine that basket is one stock. Putting all your money on one company or just a handful of companies can be extremely risky when it comes to investing. If one of those companies goes bankrupt or their performance suffers, your investment will suffer too.”
You don’t want the success of your investment portfolio to hinge on a single company, so you can reduce your risk by spreading your investments across many different companies, or even other asset classes.
Additionally, different asset classes — and even different assets within the same asset classes — behave differently depending on the market conditions. Having a variety of different investments in your portfolio means that if a part of your portfolio is down, the entire thing isn’t necessarily down.
Finally, diversification can help you combine assets of different risk levels in your portfolio. For example, stocks have historically produced higher returns than bonds or cash, but they also come with more …….