Ancient Chinese merchants are said to have managed risk by dividing their goods among several ships. If one vessel sank or was attacked by pirates, the remaining ships still had […]
Ancient Chinese merchants are said to have managed risk by dividing their goods among several ships. If one vessel sank or was attacked by pirates, the remaining ships still had a strong chance of reaching their destination, helping preserve most of the shipment.
Ancient Chinese merchants are said to have managed risk by dividing their goods among several ships. If one vessel sank or was attacked by pirates, the remaining ships still had a strong chance of reaching their destination, helping preserve most of the shipment.
The same concept applies to investing.
Diversification is an investment approach designed to help manage risk by spreading investments across different areas. While diversification does not guarantee a profit or protect against loss, it seeks to reduce the impact of market volatility by combining investments that may respond differently under varying market conditions.
At its most basic level, diversification means spreading investments across asset classes such as stocks, bonds, and cash alternatives. It also means diversifying within each asset class, such as holding a range of stocks across industries and company sizes.
Consider a stock portfolio that includes a computer manufacturer, a software developer, and an internet service provider. While the portfolio includes multiple companies, it may still be concentrated within a single industry — technology — leaving it exposed to similar risks.
By contrast, a portfolio that includes a technology company, a pharmaceutical manufacturer, and an energy services firm may offer broader diversification because those industries can be affected differently by economic and market conditions.
The same principle applies to fixed-income investments. A bond portfolio invested solely in long-term U.S. Treasuries may offer limited diversification. A portfolio that includes a mix of short- and long-term Treasuries, along with corporate bonds, may provide exposure to a wider range of interest rate and credit environments.
Diversification is one reason mutual funds and exchange-traded funds, or ETFs, are widely used by investors. Mutual funds pool money from multiple investors and invest according to the objectives outlined in the fund’s prospectus. Those objectives may be broad, such as large-cap stocks, or narrow, such as a specific industry or sector.
ETFs function in a similar way and also may have either broad or narrow investment objectives. Generally, the narrower the focus of a fund, the more limited its diversification. Narrow investment objectives also may result in greater volatility and additional risks tied to specific industries or sectors.
Understanding diversification is an important part of evaluating an investment portfolio. A well-diversified portfolio is designed to balance opportunity and risk, recognizing that markets and asset classes do not move in tandem.
If you would like more information about diversification or have questions about how your money is invested, consider speaking with a qualified financial professional who can help review your individual situation.
Mutual funds and exchange-traded funds are sold only by prospectus. Investors should carefully consider investment objectives, risks, charges, and expenses before investing. A prospectus containing this and other information is available from a financial professional and should be read carefully before investing. Shares, when redeemed, may be worth more or less than their original cost.