When working on your investment portfolio, you will continuously hear the term investment diversification. However, do you know what this term really means? In the simplest terms, diversification refers to the practice of spreading your investment funds out rather than putting them all into one place. Ideally, you will want to allocate your assets to ensure that if some of your stocks, bonds or other investments go down, you will not lose everything you have invested. With a variety of assets in your portfolio, you can reduce your portfolio’s overall risk. How you diversify will depend on your personal risk tolerance, investment funds, and your long-term goals for the investment portfolio.

What are the Possible Options for Investment?

To truly diversify your investments, you want to not just choose many different stock options, but also choose from a variety of asset classes. Asset classes have three main categories: stocks, bonds and cash. You choose between the various options to create your ideal risk level. You want to balance between non-risk, which does not bring any growth, and too much risk, which puts you at risk of a financial disaster.

1. Stock Options

The stock market is the riskiest of the three categories of assets. You can choose between small cap, mid cap and large cap stocks, as well as the different styles of stock. When you look at the different stocks, you will find them categorized by their style, which will be labeled as international, blend, value, and growth. These categories assist you in knowing the potential for growth and risk of the stock. The right stock can bring you exponential yields, but that can just as easily slip away when the market takes a downturn.

2. Bonds, Cash and More

Bonds have a lower risk, but also a lower return. They are typically sold by private companies or the government and will have set maturity dates that can range from less than a year to 30 years. Cash investments tend to be bank accounts, such as savings accounts or other investment accounts. These have almost no risk, but they also have minimal growth. You can also choose to make investments in other assets, such as real estate, gold, or art.

Allocating Investments

The most important aspect of investment diversification is the allocating of the assets. There is no simple or magical formula. The allocation you create for you portfolio will depend on your risk tolerance, your investment stage, your plan for the investment funds, and more. Younger investors might choose to be more risky with their funds, while those nearing retirement might need to play it safe or put more of the funds into cash assets. You also will allocate and diversify within each asset class to protect your investment.

Long Term View

One of the reasons that investment diversification works is that it capitalizes on the long-term approach to investment. It is difficult to know how the stock market and other assets work in the short term. The worth of your assets may go up or down, depending on the year and the financial market. However, by spreading out your investment and balancing it among various assets you have a diversified and balance portfolio that can withstand most downturns and in the long run bring you more money than you typically can make if you invest in only one area.