Lets Talk Money Online - The benefits of diversifying your investments

With the wild ride of last decade's stock market hopefully behind us, what did financial consumers learn? One might argue that diversification* can potentially help reduce volatility, disciplining investors to spread their investment dollars among different investments.

To appreciate diversification, you first need to understand why it's important. Some financial pundits have called the first decade of the 21st century the Lost Decade due to the stock market's performance. For example, large cap stocks, as measured by the Standard & Poor's 500 (S&P 500) Index, lost value during a full calendar decade for the first time ever.** If a good portion of your portfolio was not made up of equities, you owned fewer investments that were caught up in the wild stock market ride.

When you diversify your investments, typically you spread your investment dollars across the three main asset classes: stocks, bonds and cash. You might also diversify further into other areas, such as real estate and precious metals to name a couple.

If you invested $100 in stock mutual funds*** that lost 20%, you would have $80 left. But if you put $50 in stock mutual funds and $50 in another investment that gained 0%, you would have $90 remaining -- a loss, but a smaller one, thanks to diversification.

Taking this hypothetical example further, if the second $50 had a 5% gain, you would have gotten $92.50 back. Diversification does not guarantee a profit, but it can help you maintain a more appropriate investment allocation.

** "Will stocks' 'Lost Decade' usher in another bull market?" by Adam Shell, USA Today, 1/3/10

*** Because mutual fund values fluctuate, redeemed shares may be worth more or less than their original value. Past performance won't guarantee future results. An investment in mutual funds may result in the loss of principal. Mutual funds involve risk and are offered by prospectus only, which you can get from your registered representative. Carefully consider investment objectives, risks, charges and expenses of the investment company before investing. The prospectus will include this and other information; read it carefully before investing. Investing involves risks and there is no guarantee that any one strategy protects against a loss in a declining market. You should consult with your financial professional regarding your particular situation.

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