"Don't put all your eggs in one basket!" is probably what everyone will tell you about investments. This old saying just means that you shouldn't put all of your money into one company or industry when you're investing. Diversification is the name of this way to invest, but there's more to it than just following a cliche.
How to Understand Differences
Diversification means putting together a portfolio of investments that tries to lower risk by using different types of investments and investing in more than one company and more than one industry.
With a diversified portfolio, if one industry or company fails or takes a big hit, the rest of your investments should be strong enough to weather the storm and help lessen the effects of the loss. Diversification lowers your risk as a whole. On the other hand, if you put all of your money into the stock of a single company and it fails, your investment portfolio and net worth will take a big hit and go down along with the stock's value. Also, if you invest in multiple companies in the same new technology sector and that technology doesn't take off, your pocket will feel the pain of a failed technology and you may lose your investments!
Diversifying an investment portfolio better means putting money into more than just company stocks. If you have a wide range of investments, like stocks and bonds, retirement plans offered by your company, high-interest savings accounts, and cash, you will have a good mix of high-risk and medium-risk investments.
Most of the time, it's better for young investors to take more risks and be what's called a "aggressive investor." This is because you have more time before you need your investments for retirement, so your money has more time to recover if it takes a few hits. A young investor's portfolio might be made up of 80% stocks and 20% bonds, while an investor who is getting close to retirement might be more cautious and have the opposite mix of investments. No matter how old you are or whether you want to be risky or safe with your investments, a diversified portfolio will lower risk, and a mix of different types of investments will make a well-balanced portfolio.
Easy Way to Spread Out Your Investments
"A single balanced mutual fund" might be a good choice for people who only have a small amount of money to invest or who want the easiest way to build a diversified portfolio.
Single balanced mutual funds already have a mix of stocks and bonds in them, so all an investor has to do is put money into that single fund to make a portfolio that is diverse.
If you like picking your own stocks and bonds from different companies and industries, you won't be happy with single balanced mutual funds because the investments within the fund are chosen for you. But these funds are the best choice for people who want to invest but don't know what to invest in.
Even for people with a lot of money to invest, a single balanced mutual fund is probably not the best choice. Large investors should try to avoid paying too much in capital gains taxes by choosing investments that can help them build steady streams of income.
Adding to the variety
One way to make your portfolio even more diverse is to invest in things other than stocks, bonds, retirement funds, and cash. You could, for example, put your money into real estate trusts or hedge funds.
