Just like the old warning against putting all of your eggs in one basket, if you put all your money in one company stock and it dropped like a rock, you’d lose everything. Diversification can help protect your portfolio from that scenario.
Diversification is the practice of spreading your money among different investments to reduce your risk of losses.
A portfolio should be diversified at two levels; both between asset categories, such as stocks, bonds and cash; and within those asset categories.
Ideally, if one investment is losing money, another will be making gains. To diversity between asset categories with stocks holdings, for example, you’d invest in a wide variety of industry sectors, such as energy, technology, financials, health care and utilities. Then you would diversify again, within those sectors. There are many ways to diversify within sectors: invest by company, such as Google or Apple in the tech sector; by geographical market, like domestic or international or by company size, large-cap, mid-cap or small-cap.
Many people choose to diversify their portfolios with mutual funds or Exchange Traded Funds. These funds hold shares in a variety of companies, making it easier for investors to own a small portion of many investments.
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