Heard the adage about not putting your all your eggs into one basket? The same concept applies to protecting your investments. It’s called diversifying and it essentially means spreading your investment dollars strategically among different assets and asset categories to reduce risk. Here are three ways to do it.

1. Spread your risk

If you invested all of your money into one company’s stock and it plunged, you’d lose your money. If you put all of your money into a single bond and the issuer declared bankruptcy, you’d lose your funds, too. Diversification is about avoiding such scenarios by choosing different investments and types of investments. That way, your money isn’t quite so vulnerable to market movement. Ideally, when one investment is down, another may be up. Diversification doesn’t guarantee profits or protect against loss, but it can help protect your portfolio.

2. Diversify across asset classes

A well-diversified portfolio combines different types of investments, called asset classes, which carry different levels of risk. The three main asset classes are stocks, bonds, and cash alternatives. (Some investors also add real estate and commodities, like gold and coal, to the list.) Stocks generally carry the most risk of the three main asset classes, but they also offer the greatest potential for growth. Bonds are less volatile but their returns are more modest, and cash alternatives are generally considered to carry the least risk, with the lowest returns. Each asset class tends to perform differently under similar market conditions. Asset allocation, or splitting your assets among categories, helps to balance your portfolio. Investors typically choose a percentage they want to invest in each asset class based on their risk tolerance, years until retirement, and other factors. For example, you could choose to invest 80% in stocks, 15% in bonds, and 5% in cash if you were seeking higher potential returns and were comfortable with some risk. A person just a few years from retirement might shift money out of stocks and into bonds or cash for a more conservative allocation.

3. Diversify within asset classes

Once you’ve diversified by distributing your investment dollars among stocks, bonds, cash, and possibly other categories, you need to diversify again. This time you should diversify within each asset category. Within your bond holdings, for example, you should diversify by risk and have some holdings that come due sooner and others that mature in a decade or more.

When it comes to stocks, the possibilities for diversification are vast. You can diversify by the size of the companies (large-, medium-, or small-cap stocks), by geographical market (domestic or international), and by industry and sector, for example. If you want to diversify but don’t have the time or inclination to do so, consider mutual funds or exchange-traded funds. These funds generally hold shares in many different companies and are managed by professional fund managers. There are also funds that shift their asset allocation away from equities as it approaches a certain target date. These target date funds are geared towards retirement planning where the target date approximates the retirement date of the investor.

Your diversification strategy should be tailored to your personal financial goals and tolerance for risk. If you’re uncertain about how to diversify, seek the guidance of a Financial Advisor.

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