The well-known saying “Don’t put all your eggs in one basket” is just another way to say diversify your investments. Diversification is an outstanding safeguard to help reduce the risk of investment. At the turn of this century, thousands of people did not heed this age-old advice. Instead, they invested all their assets in high-tech stocks and lost.
“You need not only to hold different major asset categories like cash, bonds, stocks and real estate, but also to diversify your holdings within each category” (The Random Walk Guide to Investing: Ten Rules for Financial Success, p.96).
Diversifying Asset Categories
- CASH: It is not necessary to diversify cash investment. A money-market fund has an assortment of short-term securities issued by government, banks, and high-quality corporations. For a bank CD, only diversify so that you have no more than $100,000 in any FDIC institution.
- BONDS: It pays to diversify bonds.
- STOCKS: Index funds help provide this safeguard of diversification. They are funds that hold all or a representative sample of all the stocks in the broad stock market index. They guarantee the rate of return provided by the stock market.
- REAL ESTATE: For real estate investment trusts, diversification is absolutely necessary. Holding REITs in a single area of the country is risky. If that region does poorly, so will the REIT. It is recommend to diversify REITs by both region and property type.
For investors with vast financial resources, it is advisable to invest in both the U.S. stock index along with stocks from the world economies. Use the EAFE index for tracking stocks from Europe, Australasia, and the Far East.