Diversification: There's no crystal ball
Once you've chosen your asset mix, you'll select specific investments. By building a diversified portfolio, you can vastly lower your risk.
POINTS TO KNOW
- Buying a winning stock that makes you millions sounds great, but it's impossible to predict which stocks are winners. And if you choose incorrectly, you could lose everything.
- The more stocks and bonds you own, the more protection you have against loss—and the more chances you have to pick winners.
- It's easy to get the diversification you need through mutual funds and ETFs.
No one can see the future—and luckily, you don't have to
We've all heard stories about the great-grandfather who bought a share of Coca-Cola stock in the 1920s—and who's now a multimillionaire. But what about everyone else?
The problem with identifying a single investment that's going to make a ton of money over the next few decades is that no one has a crystal ball.
Sure, now Coke looks like a smart investment. But back then, this legendary investor put the equivalent of several hundred dollars into something that was far from a sure thing.
If you can't find the needle, buy the haystack
There's always a risk of losing money when you invest. The good news is that you can avoid one type of risk—the risk of investing everything in a company that goes under—by buying hundreds or thousands of securities at a time.
This is what's called "diversification." It works best when you buy into multiple industries and include companies of all different sizes because this variety helps even out the ups and downs.
"Sounds great," you might think, "but where am I going to get the money for thousands of investments—and the time to find them?"
Luckily, that's exactly what mutual funds and ETFs (exchange-traded funds) are for. They find and invest in a diversified portfolio of individual stocks or bonds, and you, in turn, buy shares of the fund.
Usually refers to common stock, which is an investment that represents part ownership in a corporation. Each share of stock is a proportional stake in the corporation's assets and profits.
The strategy of investing in multiple asset classes and among many securities in an attempt to lower overall investment risk.
A type of investment that pools shareholder money and invests it in a variety of securities. Each investor owns shares of the fund and can buy or sell these shares at any time. Mutual funds are typically more diversified, low-cost, and convenient than investing in individual securities, and they're professionally managed.
A type of investment with characteristics of both mutual funds and individual stocks. ETFs are professionally managed and typically diversified, like mutual funds, but they can be bought and sold at any point during the trading day using straightforward or sophisticated strategies.
The sum total of your investments managed toward a specific goal.
A bond represents a loan made to a corporation or government in exchange for regular interest payments. The bond issuer agrees to pay back the loan by a specific date. Bonds can be traded on the secondary market.