We probably all can recall hearing our mother say, “Don’t put all your eggs in one basket.” That solid advice to diversify is often misapplied to the investing front. Some investors think that buying 50 blue chip stocks complies with that adage. Others figure that buying ten mutual funds properly diversifies their portfolio, only to find that those ten mutual funds invest in many of the same stocks. Still others think hiring multiple advisors will ensure a truly diversified portfolio, but soon discover that those advisors use similar funds and that the management fees are higher than they would be with just one advisor. So what does not putting all of your eggs in one basket mean?
True diversification means owning all of the stocks that make up the market, and it is the only true way to ensure you get market returns. Further, spreading your money between stocks, bonds, and cash–asset classes that historically have responded differently to market conditions–is your best defense against being hurt by poor performance in any one asset class. History teaches us that, like a seesaw, as some investments decline, others rise to offset those losses. Additionally, you should diversify within asset categories by sub-asset class, even by investment style. Note, too, that diversification in any asset category is achieved more effectively through asset class mutual funds rather than with individual stocks. Building a diversified portfolio requires identifying your asset allocation strategy, diversifying within each asset class, and then periodically rebalancing your portfolio.
In honor of Mother’s Day, think back to what your mother told you about life: Be patient. Do your best. Look before you leap. Remarkably, her words of wisdom have a direct application in today’s markets.