Diversification Is a Good Thing: CFP Board Consumer Advocate Offers Tips on Which Assets to Diversify and How
Diversification is a good thing; it is the most effective, least expensive, and easiest-to-implement strategy in an investor’s toolbox to reduce the risk of loss, without sacrificing return. The concept of diversification is readily grasped in a bit of homespun wisdom: when your mother advised “not to put all your eggs in one basket,” she was telling you to diversify.
“If you invest only in one stock, your wealth will inevitably fluctuate with the health of the U.S. economy, changing tax laws, and the vagaries of the stock market,” says CFP Board Consumer Advocate Eleanor Blayney, CFP®. “But you will also face all the risks that threaten that one company, such as a lawsuit, management turnover, or a product recall. This kind of risk can be diversified away by investing in other companies, in other industries, or in other geographic markets. The moral is: stay diversified.”
In her latest contribution to LetsMakeaPlan.org, Blayney tackles not only the “why” of diversification, but also suggests the questions you should be asking when diversifying your assets:
- How diversified should I be?
It used to be that you could diversify by holding three basic asset classes: stocks, bonds, and cash. But trends over the past 40 years have made this approach too simplistic. With globalization and the creation of marketable securities for illiquid and directly-held assets, it is possible—and advisable—to expand one’s investment repertoire.
- Is it possible to do too much diversifying?
Yes, particularly when investors uncritically believe that more is better than less. It has been shown that sufficient diversification of a U.S. stock portfolio can be achieved with approximately 10-13 stocks.
- What other risks can be diversified?
Beyond asset classes, other areas in an individual’s financial life can all benefit from diversification, including human capital (the skills, education and professional experiences brought to the workplace), the type of accounts used for investing, and for large investments, acquisition costs.
“There is no one diversification strategy that fits all; personal circumstances matter,” says Blayney. “With holistic financial planning provided by a CFP® professional who focuses on individual needs and goals, you can pair financial planning and diversification, and get two ‘good things’ to work together for better results.”