Diversification: Don't put all your eggs in one basket

What is diversification? Diversification refers to the spreading of risk by placing assets in a variety of investment classes and in a broad range of investments within each class.

Why is diversification important? Diversification decreases risk and reduces fluctuations in portfolio returns. Historically, the returns of the three major asset classes—stocks, bonds and cash—have not moved up and down at the same time. Market conditions that boost the value of one asset class can have a neutral or negative effect on other asset classes. For example, when stock prices fall, bond prices often rise because investors move money into what is considered a less risky asset class. Diversification can’t reduce most risks related to war, terrorism and political instability, which affect markets as a whole. However, in general diversification protects portfolios from excessive losses by reducing the impact of downturns in particular asset classes or securities.  

How much diversification is enough? A diversified portfolio must be diversified at two levels: among asset classes and within asset classes. Asset allocation—based on your investment goals, time horizon and tolerance for risk—determines the optimal apportionment among investment classes such as stocks, bonds and cash. The next step is to diversify within each asset class. This involves investing in a wide range of securities with differing characteristics. For example, the stock portion of a portfolio might include large-cap, mid-cap and small-cap, growth and value stocks in a variety of industries, both domestic and international. Studies show it takes at least 50 stocks, spread among five to six non-correlated market areas, to achieve effective diversification in the stock asset class alone.

How can I diversify my portfolio? Some investors select their own individual stocks and bonds. However, most people have neither the time nor the expertise to make and manage these selections properly. Many investors choose to diversify though mutual funds. A mutual fund is a fund operated by a company that pools money from many investors and invests it in stocks, bonds, and other financial instruments. If you choose to diversify though mutual funds, make sure the funds you choose accurately implement your overall asset allocation plan.

Another option, particularly for investors with more than $1 million to invest, is to hire a reputable investment adviser, or money manager. These are professionals responsible for the securities portfolios of individual and institutional investors. In return for a fee, they take fiduciary responsibility to manage assets prudently. Karpus Investment Management is an investment advisory firm registered with the U.S. Securities and Exchange Commission. KIM brings a track record of more than twenty years of consistently outstanding performance for clients.   

Buyer beware: Before you hire anyone to help you with investment decisions, be sure to understand how they work with you and what fees they charge. Do a thorough check of their credentials and disciplinary history. One place to start is with the U.S. SEC website: http://www.sec.gov/investor/brokers.htm