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Diversification in investing means
acquiring securities with assets that are unrelated to one another.
For instance, a diversified stock portfolio might include
technology, food service, and petroleum industry stocks. The products and markets
of these companies are unrelated enough that no one economic factor—like a drop
in oil prices, for instance—will have a dramatic effect on the performance of
the entire portfolio.
It is not easy to design a diversified portfolio. First, there is
the time-consuming task of weighing and balancing the risks of each investment
you include in your portfolio. You also need sufficient capital to purchase the
broad scope of investments needed in sufficient quantities to take advantage of
low transaction costs.
Diversification is built in to mutual funds. Mutual funds collect
money from many investors, pool it, and then buy different securities. These
investments may include stocks, bonds, money market instruments, and
derivatives. How much of each type of investment a fund buys depends on what the
fund's objective is. If the objective is growth, the fund may choose more
stocks. If it is to pay its shareholders steady income, it may choose bonds and
other interest- or dividend-paying securities.
Diversification lets you spread investment risk over several
companies, industries, and types of securities. By investing in different types
of securities, you also minimize the risks inherent in each market. When one
market goes down, another may go up. Stocks, bonds, and other assets do not all
rise and fall together. Therefore, when you have several different securities in
your fund and one of them performs poorly, that one will not overly hurt the
For investors with little time for or skill at managing a
portfolio, mutual funds include an attractive service. Read about it in our next