Diversification can be a complicated process. Knowing if and when you diversify is an even trickier endeavor.
When all is said and done choosing to diversify is based on three simple things : time, money, and desired return. There are three types of investments : bonds, mutual funds, and stocks.
Bonds are loans to the government. The government makes a promise that they will pay the principle back as well as interest on the money invested. Bonds are extremely low risk and because of that they offer very little return in profit.
Mutual funds collect money from other investors. The mutual fund then invests in stocks, and bonds as well as other securities. When mutual funds gain they pass the profits on to the investors. When mutual funds loss they pass the loss onto the investor also.
Mutual funds offers a couple of benefits. They allow for diversification as well as pricey professional management at little cost. This is a great way to make money without having to pay constant commission to your broker.
When you buy stocks you are buying part of company. Investing in particular company means that your profits and losses will be linked to how well the company performs. Stocks are extremely risky because there is no protection in place that can guarantee a solid flow of money or success. Stock investing takes a great deal of research however if you make good investing decisions, it can have a high rate of return.
Diversification is way to limit the risk involved in investing. Knowing if you should diversify depends on your situation and the goal of the investing like retirement, education, or simply to increase your net wealth. If you are saving for retirement it is probably a good idea to diversify to keep risk lows.
If you are in need of stable income, that is extremely safe, then bonds might be a great option. However, picking one does not exclude the other.
Decide what percent of your portfolio will be based on each option dependent on your needs. For the causal investor a 45% bonds, 35% funds, and 20% stocks is a great way to diversify and make money.
Before you invest it may be wise to seek out and speak with a professional advisor to help you establish a financial plan and point you in the right direction.
Be warned that financial advisors have motives of their own beyond helping your potential net wealth. While they may claim they must diversify to protect your money they are also diversifying to protect their companies track record and reputation.
Brokerage advisors also make a fairly hefty commission on the whatever stocks you purchase. Make sure his decisions are based on your wants not his wallet.
For individuals who have just a small amount of money to invest (under $3000) then mutual funds are a great place to begin. Diversification works well here because you are getting the benefits of multiple stocks without having to pay commissions on each individual stock.
This is perfect for the causal investor because much of research (news, tips, charts, events) is done and provided to the investor by the mutual fund company.
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