Heard the adage about not putting your all your eggs into one basket? The same concept applies to managing your investments. Diversification essentially means allocating your investment dollars strategically among different assets and asset categories to help manage risk. Here are three ways to do it.
1. Spread your risk
If you invested all of your money into one company’s stock and it plunged, you'd lose some if not all your money. If you put all of your money into a single bond and the issuer declared bankruptcy, you'd lose some if not all your funds, too. Diversification helps mitigate the risk to you about such scenarios by choosing different investments and types of investments. Diversification doesn’t guarantee investment returns or eliminate risk of loss including in a declining market.
2. Diversify across asset classes
A well-diversified portfolio combines different types of investments, called asset classes, which carry different levels of risk. The three main asset classes are stocks, bonds, and cash alternatives. Some investors also add other investments, such as real estate and commodities, like gold and coal, to the list. Stocks generally carry the most risk of the three main asset classes, but they also offer the greatest potential for growth. Bonds are less volatile, but their returns are more modest, and cash alternatives are generally considered to carry the least risk but with the lowest returns. Each asset class tends to perform differently under similar market conditions. Asset allocation, or splitting your assets among categories, helps to balance your portfolio. Investors typically choose a percentage they want to invest in each asset class based on their risk tolerance, years until retirement, and other factors. A person just a few years from retirement might shift money out of stocks and into bonds or cash for a more conservative allocation.
3. Diversify within asset classes
Once you’ve diversified by distributing your investment dollars among stocks, bonds, cash, and possibly other categories, you may need to diversify again.
For example, when it comes to stocks, the possibilities for diversification are vast. You can diversify by the size of the companies (large-, medium-, or small-cap stocks), by geography (domestic or international), and by industry and sector, for example. If you want to diversify among stocks but don’t have the time or inclination to do so, consider mutual funds or exchange-traded funds. These funds generally hold shares in many different companies. There are also funds that shift their asset allocation away from equities as it approaches a certain target date. These target date funds are geared towards retirement planning where the target date approximates the retirement date of the investor.
Your diversification strategy should be tailored to your personal financial goals and tolerance for risk. If you’re uncertain about how to diversify, consider seeking the guidance of a Financial Advisor.
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This information is provided for educational and illustrative purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Investing involves risk, including the possible loss of principal. Since each investor's situation is unique, you should review your specific investment objectives, risk tolerance and liquidity needs with your financial professional to help determine an appropriate investment strategy.
Mutual Funds and Exchange-Traded Funds are subject to risks similar to those of stocks. Investment returns may fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed, or sold, may be worth more or less than their original cost. Exchange Traded funds may yield investment results that, before expenses, generally correspond to the price and yield of a particular index. There is no assurance that the price and yield performance of the index can be fully matched.
Stocks are subject to market risk, which means their value may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Investments in equity securities are generally more volatile than other types of securities.
Investments in fixed-income securities are subject to market, interest rate, credit, and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can cause a bond’s price to fall. Credit risk is the risk that an issuer will default on payments of interest and/or principal. This risk is heightened in lower-rated bonds. If sold prior to maturity, fixed-income securities are subject to market risk. All fixed-income investments may be worth less than their original cost upon redemption or maturity.
Cash alternatives may be sensitive to interest-rate movements, and a rise in interest rates could result in a decline in the value of the investments.
Target date funds are mutual funds that periodically rebalance or modify the asset mix (stocks, bonds, and cash alternatives) of the fund’s portfolio and change the underlying fund investments with an increased emphasis on income and conservation of capital as they approach the target date. Different funds will have varying degrees of exposure to equities as they approach and pass the target date. As such, the fund’s objectives and investment strategies may change over time. The target date is the approximate date when investors plan to start withdrawing their money, such as retirement. The principal value of the funds is not guaranteed at any time, including at the target date. More complete information can be found in the prospectus for the fund.
Wells Fargo and Company and its Affiliates do not provide tax or legal advice. This communication cannot be relied upon to avoid tax penalties. Please consult your tax and legal advisors to determine how this information may apply to your own situation. Whether any planned tax result is realized by you depends on the specific facts of your own situation at the time your tax return is filed.
Asset allocation and diversification are investment methods used to help manage risk. They do not guarantee investment returns or eliminate risk of loss including in a declining market.
Past performance is not a guarantee of future results.
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