March 10, 2015 Admin | March 10, 2015 Diversification is paramount when investing. What does it mean and how do you do it wisely and cost effectively?
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Diversification is the act of owning many investments that do not have to same stakes in the market. You want to own many different investments. Just because you may own an index that does not mean you are well diversified, there are many index funds that over lap with each other. Such as the S&P and total stock market. You want to hold ones that dont own the same companies. You also want to stay away from indexs that cover a small area, such as just a German stock index or an idex that just has tech companies in it. Those are to specific of indexs to provide the diversification that your looking for from an idex. You want to hold a hand full of index funds that cover the whole world over. Such as a total stock index, and international index, a reit index, and emerging markets and small cap. With these funds you will own thousands of different stocks that will have you well diversified and protected from some of the wild swings of the market you would see with only owning a few stocks.
Diversification is a way of reducing the risk of your investments by owning assets that are negatively correlated to each other. The less closely your assets follow each other, the more diversified you are and the less risk you will have on your investments. This way, if one of your investments is down, others will be up, and it will balance out your returns.
One cost effective way to diversify would be to hold something like an index fund that contains a wide variety of stocks and bonds for a very low cost to the investor. But, like Garrett said, some of these indexes overlap and some are not diversified across the whole market, so you have to look carefully at which stocks/bonds each index is holding before you decide which ones will be best for you to invest in.
Well said. Let’s recap.
(1) Diversification reduces your risk and will very likely increase your returns over time as you avoid the extreme drops in a portfolio that is not diversified (own a few individual stocks).
(2) Mutual funds accomplish diversification quite well as they own hundreds if not thousands of individuals stocks and bonds.
(3) Index mutual funds do it at a very, very low cost, which translate to higher returns over time. Awake to the possibilities!