Diversifying funds means dividing investments into different groups to share risk and rewards. It reduces the risk of losing all investments in one area and typically results in lower but more predictable returns. Financial advisors recommend higher risk for younger investors and lower risk for older investors. Stocks are the riskiest but offer the highest probability of return, while bonds have fewer ups and downs and short-term investments are the least risky. Late investors may diversify with a higher share of risk, while those with a reasonable amount of retirement funds diversify between bonds or short-term investments.
Most people who invest are advised to diversify funds. This means taking one’s total investments and dividing them into different groups. In general, the expected goals when people diversify funds are to share both risk and rewards across a large group of investments. In general, investment profiles that diversify funds have lower but more predictable returns.
The old adage “Don’t keep all your eggs in one basket” applies to the fundamental principles of investing. If one invests in only one mutual fund, stock, or company, a loss means that the single investment may be lost. However, when people diversify funds, a loss in one area can be offset by gains in other areas. Thus, all the “eggs” or, in other words, the investment, are not lost.
In general, when people diversify funds, they invest in three separate areas. A portion of the portfolio may include the purchase and ownership of stocks, bonds, and short-term investments. The risk when people diversify funds depends in part on the percentage of money that is invested in each area.
Financial advisors often recommend a higher risk profile for younger investors and a lower risk profile for investors who are older and would be greatly affected by loss of funds. Stocks are considered the riskiest investment, so the person ventures into higher risk with a higher percentage of money invested in stocks. Stocks also represent, in many cases, the highest probability of return. The risk must be weighed against the benefits.
Investing in bonds is often part of how people reduce their risk when they diversify funds. Bonuses have fewer ups and downs, although they are also less likely to make big profits. However, they can offset investing in stocks, so not all of the money is lost, and some of the money invested in bonds is expected to generate a reasonable and fairly predictable return.
Short-term investments, such as money market funds, are the least risky investments. They also give people access to their money right away, which is not the case with long-term investments in bonds and stocks. With the lower risk in the profiles that diversify the funds also comes the lower return. Money deposited in a savings account at a bank, for example, is likely to generate minimal income. However, this money is relatively safe, especially compared to money invested in stocks.
Those who start investing late and still want to retire with a reasonable income often diversify funds with a higher share of risk. Those who have a reasonable amount of money for retirement tend to diversify funds between bonds or short-term investments.
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