Mutual Funds and Portfolio Diversification

Do you know whether all your eggs are in one basket? We have all heard this wise advice. You might think you’re following it well if you have some money in your savings account, some in CDs, and some in your 401(k). Perhaps, instead, you think that the advice only applies to big investors on Wall Street - that if you’re only quietly trying to build up your retirement account, you don’t need to think about diversification.

If so, it’s time to think again. Diversification is for everyone, and using this tool wisely can help to improve your returns in a good market, and protect your assets in a bad one.

What is diversification?

The idea behind diversification is to spread your funds into many different types of investment, so that failure in one sector doesn’t put your entire financial future at risk. One way is to divide your funds into stocks, bonds, cash, real estate, and so on - and this is wise when you have the cash to do so. Many middle-class investors aren’t able to invest on this scale, however - their only investment may be in their company 401(k), 403(b) or SEP, which usually puts their retirement monies into mutual funds.

By their nature, mutual funds are a great way to diversify — why buy five shares of a single company stock, when for the same money you can own one share in 20 (or more) companies? This helps to spread out the risk of losing all your money on one poorly run company. However, you need to have a look at which types of mutual funds your money is going into - you may have chosen only one fund, or selected blindly among several, when you first signed up for your 401(k). You may have had a default array suggested by your Human Resources person (although they’re much more careful about that these days). Either way, it’s worth a little time to see if changes need to be made.