What is diversification? It’s an approach to reduce investment risk by using a wide variety of assets instead on just one type of investment.

When I started on my financial journey, I thought I was diverse because I had three mutual funds.  I was informed that I was not as they were all stock funds.  I didn’t have any bonds, ETFs (Exchange Traded Funds), real estate, etc.  Basically, I had all of my eggs in one basket.  You can also diversify by asset class, industry, geography and size.

So how does being diverse reduce your risk?  In theory, if one of your assets aren’t doing well at a particular time, another type of asset will do better.  That will balance out your risk.  So, for example, when stocks go down, bonds usually go up.  Is that always the case?  No.  But it does happen more often than not.

Moral of the story:

So, when investing, what should you do?  Buy a mix of assets.  Don’t just buy stocks.  Buy stocks, bonds, and other types of investments.  I’m also a fan of mutual funds.  They are designed to be diverse.  They spread risk across a variety of different companies, and asset classes.