Inexperienced investors sometimes make the mistake of putting all of their money in a single asset. The problem is that the investor may eventually guess wrong and suffer a big loss. Successful investors learn to rely on diversification. Diversifying means allocating money to different assets. For example, an individual can divide his or her money between stocks and bonds.

How Diversification Helps Investors

One way to diversify investments is to buy a selection of stocks. One equity asset might perform poorly, but it is unlikely that all of them will. The investor reduces risk by spreading investment funds over several assets. However, market trends can reverse direction. For instance, an economic downturn may lead to lower stock prices. This is why savvy investors include different asset classes in their portfolios. A balanced portfolio typically includes stocks and bonds. This is a common diversification strategy because bonds often gain in value when stock are in a slump. The end result is that a portfolio performs better in the long run.

Diversifying and Individual Goals

There is no one formula for diversifying assets that is right for all investors. This is partially due to personality differences. One person may be more more aggressive than average. He or she may be willing to take risks that others shy away from. In addition, individual priorities change with time. A single person in his or her 20s with no children can accept risks that are unwise for someone with a family to support. The young investor is likely to include more growth stocks in his or her portfolio. She accepts more risk in order to grow her portfolio. Financial advisors say that each investor should develop an allocation strategy that is tailored to individual needs.

Funds and Asset Allocation

Many investors rely on mutual funds for investing. Funds are run by professional managers who have expertise the average investor does not. There are two types of funds investors should know. Passive, or index, funds attempt to match the performance of a benchmark index of assets. These funds are attractive during bull markets. However, the passive strategy has its drawbacks. When the market reverses a growth trend, an index fund will follow it downward. The managers of active funds try to beat the market by choosing stocks and bonds they think will do well. Active funds can provide excellent returns, but they also carry greater risk. However, investors don’t have to choose between active and passive funds. Following the principle of diversification, an investor can include both in a portfolio.