To diversify. To diversify. To diversify. Education investment and “diversification” are among the most commonly used terms. Indeed, the first piece of advice that many professional investors offer beginners is to diversify their investment portfolios. So what makes diversification such an important concept? Let’s dig.
First, diversification involves spreading your investments across different assets. It can mean many things. You can take your stock portfolio and then distribute the investments among various companies and industries. You can also diversify geographically, investing in Japanese, American and German companies.
You can also diversify your entire investment portfolio. Instead of investing your retirement savings solely in stocks, you could buy real estate, maybe rent houses. You can also buy precious metals, such as gold or interest-paying bonds. Less traditional assets, such as cryptocurrencies, could also come into play.
So why diversify? As the old saying goes, you don’t want to put all your eggs in one basket. Drop that basket and you risk losing all your eggs. No breakfast for you, sorry. The same is true when you invest. Everyone wants to invest in the next Apple. However, finding those diamonds in the rough is much easier said than done. For every Apple there are countless gateways, Nokias and Blackberries.
Outside of individual companies, macro trends can create headwinds for entire industries. Ford bankrupted many horse-drawn carriage builders, and computers made typewriters obsolete. Trade wars could crush the value of foreign manufacturing companies, or real estate markets could overheat, burst bubbles and destroy wealth.
Meanwhile, entire stock indices may suffer steep declines as precious metals soar. By diversifying, you mitigate risk. If a company or even an industry experiences strong headwinds, only a portion of your investments may end up exposed.