Diversification is often called the only "free lunch" in investing. It's the practice of spreading your investments across different assets to reduce risk without necessarily sacrificing returns.
Why Diversify?
Markets are unpredictable. The best-performing asset class changes every year. By diversifying, you ensure that a downturn in one area doesn't devastate your entire portfolio.
Levels of Diversification
1. Asset Class Diversification
Spread across stocks, bonds, real estate, and cash. Each behaves differently in various economic conditions.
2. Geographic Diversification
Don't invest only in your home country. Global diversification reduces country-specific risk.
3. Sector Diversification
Within stocks, invest across technology, healthcare, finance, consumer goods, energy, and other sectors.
4. Time Diversification
Use dollar-cost averaging: invest a fixed amount regularly regardless of market conditions.
Sample Portfolio for a Moderate Investor
- 40% - Global Stock Market ETF
- 20% - US Bond Market ETF
- 15% - International Developed Markets
- 10% - Emerging Markets
- 10% - Real Estate (REITs)
- 5% - Cash / Money Market
Common Mistakes
- Over-diversification - Owning 50 funds creates unnecessary complexity and overlap
- Home bias - Investing only in your country's stock market
- Ignoring correlations - Owning 10 tech stocks isn't diversification
Remember: diversification doesn't eliminate risk entirely, but it's the most effective way to manage it.