Sorry I’m a little late with this! This is my most recent column, which was in last week’s paper.
Diversification is a method of spreading out your investment risk. Most people understand the concept of diversification, even if they’re unfamiliar with the word. Diversification means not putting all your eggs in one basket.
Let’s say you’ve found a company whose stock you’d like to buy. You load up on as much stock as you can, but in spite of your thorough research, the price of a share sinks dramatically, and you lose most of your investment. The risk of loss is one of the greatest risks in investing, but diversification allows us to limit our exposure to loss. Now let’s assume you have found ten companies you would like to buy. You buy as many shares as you can, but this time you buy an equal amount of the ten different companies. If one of those companies goes bad, you’ve only lost that one small slice of your investment pie. And if your other shares have gone up, they may make up for any loss.
There are many ways to diversify. You can diversify across asset classes. This would mean buying shares of large companies and small companies; buying shares of companies that pay a dividend and companies that don’t; buying shares of companies in different industries; and even buying shares of companies in different countries.
You can also diversify across security type. Most investors have some amount of stocks and some amount of bonds, for example. Others invest in real estate and precious metals. Some even include more exotic investments, like art, old cars, or foreign currencies. If any one of these investments should lose money, it’s likely that another investment is making money.
While diversification doesn’t guarantee positive investment results, it does lower the risk of loss. In short, don’t put all your eggs in one basket. Diversify.
This article originally appeared in the November 28, 2007, edition of the Greenhorn Valley View.