An easy-to-understand description of the investment term “diversification” is “not putting all your eggs in one basket." In other words, your money is spread around. A diversified portfolio has less volatility (i.e., price swings) than if you put all of your money in one place. Diversification can be done very simply by all investors. It does not require a degree in finance or a financial adviser on retainer.
Below are some well-diversified investment ideas:
• Mutual funds, unit investment trusts, and/or exchange-traded funds that are already well diversified. Each of these investments contains professionally selected securities of a similar type. An example is a municipal bond fund that contains a portfolio of investment grade (rating of BBB, A, AA, and AAA), long-term tax-exempt municipal bonds. Typical stock mutual funds contain stock issued by over 100 companies. This reduces investment risk in the event that several individual companies within the mutual fund portfolio fail.
• Index funds are often even more well diversified than actively managed (non-index) funds. Many index funds contain multiple securities. Index funds consist of securities within a benchmark market index such as the Standard & Poor’s (S&P) 500. For the best diversification potential, look for index funds that track a broad-based index. Examples include the S&P 500 (used to track the performance of large U.S. company stocks), Wilshire 5000 (used to track the performance of all U.S. company stocks), and EAFE Index (used to track the performance of international securities). A major advantage of index funds is their low expenses because the index fund portfolio is “pre-selected” to include securities contained within a specific index.
• Fixed-income securities are items such as certificates of deposit (CDs) and bonds that are "laddered" by making purchases with staggered maturity dates. For example, buy five $1,000 bonds or CDs with different maturities instead of one $5,000 bond or CD that matures at one time. Laddering allows investors to access their money (investment principal) more frequently and benefit from changes in interest rates.
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