The Importance of Diversification in Building an Investment Portfolio

We all know that if we want to have any sort of true wealth we must do much more than work and put our money under a mattress. We all know that we have to do some investing, but if you invest without understanding, you are probably better off shoving it all under your mattress! One of the most fundamental ideas of investing is that of diversification. It may seem a little simple to some seasoned investors, but it’s still worth wholly understanding.

The selection of individual stocks is perhaps one of the best illustrations of why you should have diversification. Chances are we’ve all heard a tip about a stock which is going to go up very dramatically very soon and that we should buy it now. For Example, when Google came out, everyone wanted to buy it, and there were right to do so since its now worth over $500 per share! It doesn’t always work that way though. You could have made a killing with Google, but what if that hot stock tip was for a company such as MCI WorldCom or Enron? You’d be broke. The stock picking game is very difficult to play, and more often than not, you end up loosing because you are not diversified in your investments. You put too much of your life in one company, and it can you in trouble.

Instead of picking individual stocks, diversify. Don’t put all of your money in one just company, put all of your money in 500 companies. This process still doesn’t make sense if you invest in 100 healthcare companies or 100 real estate companies. You also have to diversify the markets you are in. The best way to do this is to get a total stock market index fund which has everything. This is the best way to go because capitalism trends upwards over long periods of time. Your risk is so diversified because your money is in so many different companies which sell so many different products.

You can diversify even more. What if the US economy as a whole has a really bad year? Your money will probably be worth less. Other countries have economies too, so perhaps consider putting your money in some companies which are outside of the United States. You can do this through getting international funds. Emerging countries are also growing at much faster rates than the US, so larger gains could be realized from developing economics such as Brazil, China and India.

Diversify in any way you can. Perhaps even consider putting some money in real estate, and in bonds, so that way your investments are all over the place and if the stock market does poorly, you will still be okay. The more diversification you have in your investments, the more likely you are to not lose your money because of an event or change in the economy.