The following is a guest post by Casey Musarra. Casey is a reformed sports journalist tackling a new game of financial services writing. Previous bylines include Newsday and Philly.com. Mike Francesa once called her a “great girl.”
If you’ve ever participated in an Easter egg hunt, you know the goal is to collect as many hidden plastic pastel eggs (filled with candy or money—hopefully, more than a few pennies if mom’s not a cheapskate) as possible in your basket.
Putting all your eggs in one basket can be a good idea in certain financial scenarios, like with debt consolidation, as it allows you to streamline multiple debts into a single, low-interest monthly payment. But keep in mind, even debt consolidation is a good idea only when you have a steady income, good credit score, and the discipline to continue making payments while avoiding adding debt.
When it comes to your investment portfolio, though, you want to take the opposite approach. You don’t want to put all your eggs in one basket. Instead, you want to spread your eggs (money) across many baskets (investment opportunities).
Here are just a few reasons why it’s important to diversify your investments.
4 reasons why you should diversify your investments
Diversification reduces risk
If you take the “all your eggs in one basket” approach, you’re putting your entire portfolio at risk with one bad swing of the market.
Picking individual stocks, like many rookie investors did with the GameStop stock saga, is a tricky game, as choosing a big winner is like finding a needle in a haystack. This is what’s considered asset-specific risk, as opposed to market risk when all assets can potentially lose value. If you do feel compelled to roll the dice with an individual stock, you should probably lean toward making that a small percentage of your portfolio instead of a large chunk to minimize risk.
You open yourself up to more ROI opportunities
Diversifying your portfolio provides more chances for growth because you’re exposing yourself (lol not like that) to different asset classes, like stocks, bonds, cash, and other commodities. Having both stocks and bonds, for example, gives you a bit of a safety net because if stock prices fall, bond prices usually go up. This is because investors change their approach to what’s thought to be a less risky investment.
But diversification isn’t just limited to asset classes. Even if you’re heavily invested in stocks, you want to split your holdings among different sizes/market capitalization, industries/sectors, styles, and regions to account for short- and long-term goals.
You can protect your investments from adverse market cycles
The best way to protect your investments from an adverse market cycle is to have a diversified portfolio. This allows you to benefit from the upswings while not being fried by the downswings. Think of your investments like fragile eggs. Even a slight crack can force you to scramble.
And, while scrambled eggs are delicious, losing all your money in the stock market is not.
Diversification lowers volatility
There’s a reason why it’s called “playing” the stock market. Like other games and sports, markets are volatile and unpredictable.
Having a diversified portfolio helps to prevent negative consequences from guessing wrong. It’s like having a staunch defense. As they say, defense wins championships.
