Business : Diversification

A risk management technique that mixes a wide variety of investments within a portfolio is called diversification. “Typically, a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio, states Brenda Schmitt, ISU Extension and Outreach Family Finance Field Specialist.

Investing in one security can result in disaster. By investing in several different securities, the impact of any one investment on the portfolio’s return is not that significant, even if that security’s value goes to zero.

Diversify your investments both by selecting a variety of asset classes, such as stocks and bonds, and a variety of securities within one asset class is a good idea. Have some of your investment dollars in a mix of cash, stocks, bonds, and possibly other asset categories and then also diversify within each of these categories.

Different industries, such as oil firms and retail firms, may act differently to changing economic conditions. For example, when oil prices increase, oil firms benefit but retailers may lose business because consumers have less money to spend after filling their gas tanks. Likewise, fixed-income investments should include both government and corporate bonds and possibly some international exposure by having bonds in companies that operate in other countries.

To adequately diversify with individual stocks and bonds, you need enough money to select a variety of investments. Mutual funds are a way for even the small investor to become diversified. A mutual fund pools dollars from many investors and assembles a portfolio designed to achieve a specific investment objective.

Time period is another type of diversification that is often overlooked. The inclination is to “time” buying and selling but this is very difficult, if not impossible, to do. It is easier to be invested for a longer period of time over different market cycles. Although there may be fluctuations over the short term when investing in stocks (for example, stocks lost 22 percent in 2002 but were up 29 percent the next year), by being invested over a longer period of time, these fluctuations can be smoothed out.

Done properly, diversification can reduce much of the total risk of investing. Even with a relatively small amount of money, all investors should diversify their investments, whatever their goals. Diversification is a cornerstone of wise investing.

Beginning in January, an 8 week series of online classes will be available through Iowa State University Extension and Outreach. For more information on specific topics and registration information, contact your local ISU Extension and Outreach office and ask about the RETIREMENT: Secure Your Dreams program information. Or contact Brenda Schmitt at 641-512-0650 or schmitt@iastate.edu.