Diversification

Spreading money across many different investments so that a loss in any single one has a smaller effect on the whole portfolio.

What it means

Diversification is the idea behind not putting all your eggs in one basket. Owning many companies, industries, countries and asset types means the failure of one holding does far less damage. It works best when investments do not all move together; when one falls, another may hold steady or rise.

Diversification reduces the risk tied to individual companies or sectors, but it cannot remove market risk, the chance that most investments fall at once, as they often do in a severe downturn. Broad index funds and ETFs offer diversification cheaply. Owning several funds that hold the same investments adds little.

Example

For example, if someone splits a portfolio equally among 20 stocks and one company goes bankrupt, the portfolio loses 5% of its value from that stock. If all the money were in that one company, it would lose 100%.

How it’s used

Building a portfolio that can survive individual company failures
Reducing concentration in an employer’s stock
Choosing broad funds over a handful of individual stocks

Strengths and weaknesses

Strengths

Limits damage from any single investment
Can make returns steadier over time
Easy and inexpensive to achieve through broad funds

Weaknesses

Does not protect against broad market declines
Also limits the upside from any one big winner
Owning many overlapping funds can create false diversification

Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.