Why Diversification Is Important
We have all heard the phrase “don’t put all your eggs in one basket”, and nowhere is that advice more pertinent than in the world of investing. When it comes to buying stocks and mutual funds it is important to build a solid and diversified portfolio. The importance of diversification simply cannot be overstated. If you are not diversified and something happens to your favorite stock or mutual fund, you could be in real financial trouble.
Those with a diversified portfolio, on the other hand, can sleep well at night, even if one or two stocks in their portfolio experience a rough time. For instance, if you limit your exposure in a single stock to 4%, even a 50% drop in that one stock will only provide a slight blip in your overall financial picture.
This kind of diversification can be difficult to achieve, especially for those who get special deals on buying stock. For instance, many employers offer their employees the opportunity to buy stock at below market rates, most often at a 15% discount. Assuming the company is healthy, these special stock purchase plans can be a great deal. The key is to periodically rebalance the portfolio by selling the stock that has vested in the account. This strategy will help you diversify while still taking advantage of a great employee benefit.
There are many ways to diversity a portfolio, but one of the simplest and most cost effective ways is to simply purchase a low cost mutual fund which invests in a diversified index of stocks. Some examples of such diversified mutual funds are ones investing in the Standard and Poors 500 and in the Total Market Index. There are a great many mutual fund companies who offer a variety of index funds at some very low expense ratios.
Keeping expenses low is of the utmost importance, as any expenses incurred will eat into your overall return. Keeping your expenses as low as possible, and creating a diversified portfolio, is one of the best ways to insure your financial future.