Investment Strategies: Diversification

Diversification is the process of allocating capital in a way that reduces the exposure to any one particular asset or risk. A common path towards diversification is to reduce risk or volatility by investing in a variety of assets.

The goal of diversification is not necessarily to boost performance—it won’t ensure gains or guarantee against losses. But once you choose to target a level of risk based on your goals, time horizon, and tolerance for volatility, diversification may provide the potential to improve returns for that level of risk.

To build a diversified portfolio, you should look for assets—stocks, bonds, cash, or others—whose returns haven’t historically moved in the same direction, and to the same degree, and, ideally, assets whose returns typically move in opposite directions. This way, even if a portion of your portfolio is declining, the rest of your portfolio, hopefully, is growing. Thus, you can potentially offset some of the impact of a poorly performing asset class on your overall portfolio.

Within your individual stock holdings, beware of over-concentration in a single stock. For example, you may not want one stock to make up more than 5% of your stock portfolio. It would be smart to diversify across stocks by market capitalization (small, mid, and large caps), sectors, and geography.