The experts liken putting all your money into a single investment to placing your entire bet on one horse at the racetrack. If you have ever done this, you’ll be aware of the sinking feeling that comes with losing everything when your horse loses. You want your investment strategy to be inclusive so that you have a better chance of getting a return on your money, even if not every one if them is a winner.
Spreading your money over several types of investment categories in called asset allocation. The typical asset classes in the investing world are stocks, bonds and cash. Alternative categories include precious metals such as gold, real estate, corporate debt, commodity futures or private equity. Investing in these various categories means that you are diversified. You also need to have diversification inside the categories. For example, adding individual stocks to your portfolio, buy into a dozen companies rather than four or five.
Stocks. You can buy individual stocks in a company or you can invest in mutual funds. These funds are groupings of stocks bundled together by an investment professional. You can have a higher risk with stocks but also a higher return. Mutual funds reduce the risk you have with individual stocks, since there will be winners in the groups as well as losers.
Bonds. These are issued by the government on all levels – federal, state and local. They are also issued by corporations. They give the issuer cash needed to fund a large project needed for improvements or expansion. They have far less risk than individual stocks. The trade-off is that you will generally get a lower return on your investment. Some people prefer to have the peace of mind.
Cash. This type of investment covers putting money into a low-interest-bearing savings account. These are very low risk but also yield a low return. It’s goof to have some of these types of investments in the mix with the riskier ones.
As an investor you have to be prepared to take the losses with the gains. There will always be losses but diversifying your investing means that you should expect to have more wins than losses. The trick is to determine what your personal tolerance for risk is. If you can’t take the stress, then put more of your money into lower risk investments. If you have daring blood you will be able to handle more volatile investments. Diversification happens at two levels – in the various investment categories and within each category. This can be challenging but worth it when it’s time to take your profits.
