Diversification
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Position yourself for opportunity.
When you first start investing, you must initially decide how to spread your money across the three primary
asset classes: equities (stocks and stock mutual funds), fixed income investments (bonds, bond mutual funds,
and Certificates of Deposit [CDs]) and cash equivalents.
(See Asset Allocation.) In the beginning, you may have just one or two
investments in each class.
As your portfolio grows, you’ll probably want to diversify by increasing the number and type of holdings
within each asset class. Diversification is a proven tool for reducing volatility — the extreme, often
sudden, up and down movements of investments — and managing risk.
- In changing markets, different investments may go up or down at different times or to varying degrees.
- Stocks and bonds sometimes react differently to economic events, and bonds may rise when stocks fall or
vice versa.
- Investments in one industry or sector may be rising or holding steady while investments in another area
may be falling.
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Mutual funds: instant diversification
For many individuals, mutual funds are the most effective way to diversify broadly. Mutual funds, which are
run by professional investment managers, pool the money of thousands of investors to purchase a diversified
selection of securities such as stocks, bonds or money market instruments. Since mutual funds tend to
"specialize" in certain types of investments, you may decide to buy a range of funds to further diversify
your portfolio.