If everything in your investment portfolio always goes up or down at the same time, then you’re not diversified.
Diversification is one of those buzz words in the investing world that we’re taught is good (and it is!), but we don’t really dive into it very often. We hear the pithy phrases like “Don’t put all your eggs in one basket.” That makes sense to most of us. But what really is diversification?
Sometimes different assets go up and down in price at different times. Some days stocks are up, while bonds are down. Or international stocks are up while US stocks are down. Or growth stocks beat value stocks. Not everything moves in the same direction all the time, and the relationship between different assets moving up and down can be measured statistically (I promise not to get into any math here!).
Diversification is the process in which you buy a variety of assets with the goal of reducing overall risk. When one thing is down, something else might be up. My crystal ball is a little cloudy today, so I don’t know what will be up or down tomorrow. If I did know, I wouldn’t need to diversify, I’d only buy the winners! Obviously, I don’t know that, so the best course is to invest in a diversified manner.
Which means something in the investment account always looks worse, and might even lose money, compared to the best performer in the portfolio. That’s why I say there’s always something to apologize for – the very act of diversifying means we’ll always have some investments doing better than others. That’s a function of a good portfolio!
Please note: Diversification and asset allocation strategies do not assure profit or protect against loss.
