Diversification means not putting all your eggs in one basket. If one investment falls hard, the others may soften the blow.
What it looks like
You can spread across many companies, different industries and different kinds of investments. A fund holding hundreds of companies is one way to do that in a single step.
What it cannot do
Diversification lowers one kind of risk. It does not remove the risk that the whole market falls. In a bad year, most things can drop together.
Common mistakes
Owning ten stocks in the same industry is not really spread out. Owning too many things you do not understand is not helpful either.
Practice
Try Which Sector to see how industries differ, and the glossary for the key terms.
Play: Try Which Sector.
A quick picture
Imagine three companies: a grocery chain, a software firm and an energy producer. A bad year for one does not always hit the others at the same time. Owning all three smooths the ride compared with owning only one.
Ways to spread out
Across companies, industries, company sizes, countries and asset types such as stocks and bonds. A fund can do much of this in one holding.
Over diversifying
Owning too many things can make it hard to follow what you have. Many people prefer a simple mix they understand over a long list they never review.
Common questions
How many investments do I need to be diversified?
There is no magic number. The idea is to avoid depending on one company or one industry.
Does diversifying remove risk?
No. It lowers the damage from one bad pick but cannot protect you from a broad market fall.
Is an index fund diversified?
A broad index fund holds many companies, which spreads risk across them.
Keep reading
- Money Ladder: Ten Questions to the Top
- The Rule of 72: Double Your Money Math in Your Head
- Learn investing one small idea at a time
Education only. This is not investment advice, and investing involves risk, including loss of money.
The problem
If all your money sits in one company and it fails, the loss is large.
The fix
Own different kinds of investments so no single one decides your result.
Examples
Different industries, company sizes and asset types.
Limits
Diversifying lowers risk but does not remove it or guarantee gains.
Education only
Not advice.