Posted on August 28th, by Eric Hutchinson in Hutchinson Blog. No Comments

Continuing with our Back to School series, and building on our introduction to stocks and bonds mutual funds, and ETFs. today’s topic is diversification. Diversification is a foundational investment principle that everyone should keep in mind when making smart investment choices.

At its core, investment diversification can be summed up as: “Don’t put all your eggs in one basket.”

When it comes to the world of investment choices, winners always change — a company or industry sector that is hot one day can be cold the next.

For that reason, if you have too large a portion of your total investment assets invested in any one security or type of security, you may experience problems when change occurs. No matter how good and solid an investment opportunity appears, there is always the possibility that something can — and will — go wrong.

Diversification is all about preparing for when Murphy’s Law impacts your investments. Through diversification, we position your hard-earned money so when one investment goes down, your other investments go up and counterbalance. In addition, the losses that might occur in that one investment don’t represent the lion’s share of your account value.

Consider the recent example of what happened starting in 2007 and into 2008 and 2009 to investors with too much money in the real estate market. As property value bubbles burst around the country, they experienced significant losses in the value of their accounts.

Or think about another bubble of the past: the Dot Com bubble of the late 1990s. How many of those Internet and technology companies, with such entertaining Super Bowl ads and so many people invested heavily in their company stocks, are even still around today? For the unfortunate investors that weren’t properly diversified beyond such companies, that bubble bursting was a very costly and painful experience.

Diversification is a powerful investment tool that can help protect you from concentrating too much risk in any single security or class of investments.

Diversify your investments. Spread your eggs over many baskets. You will be safer in the long run.

And as a final word of caution, having multiple of similar investments usually wont work as a diversification method, so owning shares of four different mutual funds or ETFs that are all investing to match the S&P 500 index would not be a diversified investment portfolio.