Jan 18th, 2008
Recently at work a coworker was in the break room talking about how they have a “fully diversified portfolio.” Because I am a smart ass, I asked them how I could convert my partially diversified portfolio into a full diversified portfolio. She of course had no idea how I could do so because, well, she had no idea what she was talking about. So I thought maybe it would be a good time to give a good overview about what exactly this means.
The basic idea is very simple: invest your money into a bunch of different places so that you don’t have all your eggs in one basket. To take it a step further it generally means spreading your investments around into different investment areas such as stocks, bonds, mutual funds, money markets, gold, real estate, and the hippies down the street selling beads. If I were you, Id stick to the first few.
There are a few different types of diversification:
This is when you diversify between same type investments. So this is like buying stock in Microsoft and Enovia.
Vertical Diversification is the investment between different types of investment. It can be a really broad diversification, like diversifying between bonds and stocks, or a more narrowed diversification, like diversifying between stocks of different branches. This gives much more protection against changing economic conditions or say the collapse of the stock market.
As a general rule the upside of diversifying is that you have protection from losing all of your investment should something go wrong with one company or one sector. The downside is that the average of all the investment parts will always be below the return of the top performer. Stocks have the greatest upside, but also can have a huge downside where as some things such as bonds tend to be lower performers but stable. Just one more thing to think about.