Diversification
means creating an investment portfolio that contains different
types of investments within each of the major
asset
classes
— stocks, bonds, and cash. A diversified
portfolio might include stock in several different companies or
a number of stock mutual funds, government and corporate bonds,
and
U.S. Treasury bills.
You might diversify a larger portfolio even further by including
a range of investments from other asset classes, such as real
estate or
options.
When
you diversify, you choose between different
subclasses
of investments within each asset class. Each subclass is similar
to other investments in its class, but also has some distinctive
characteristics. For example, the stocks of large and small companies
are both
equity investments.
But the two tend to increase in value at different rates and expose
you to different levels of investment
risk.
Branching out
Finally, each subclass is made up of hundreds,
and sometimes thousands, of separate investments for you to choose
among. For example, the stocks of the five hundred companies included
in
Standard
& Poor's 500-stock Index are usually all considered part of
the subclass of large-company stocks.
In some ways, it's easier to understand diversification
by explaining what it is not:
If the only stock
you own is stock in your employer's company, your
portfolio isn't diversified
