Guard Your Investment with Diversification

When you invest in the market, the one thing you can be sure of is that it will fluctuate in ways no one can predict - it is the nature of the market. Since the market is unpredictable and volatile, you will want to have a strategy in place to minimize the impact of volatility. One way to reduce the impact of volatility is to diversify your portfolio.

Creating a well diversified portfolio can begin with considering three asset classes: equity, fixed income, and cash. Stocks, or equity investments, carry the most risk, but may also have the most potential for high returns. Bonds are considered fixed income, and are less risky with lower potential returns. Cash investments have the lowest risk, and generally the lowest return. Here's how you can diversify your portfolio even further:

Know your risk tolerance. One of the keys to investing is knowing the level of risk you are comfortable with. If you take on too much risk, you might overreact to market fluctuations. If you jump out of the market when the market goes down, you are likely to miss getting back in before the market goes up, and risk earnings.

Determine your time horizon. The amount of time you have to invest before you expect to begin using the money will affect the type of investments you choose. You may be comfortable with more risk if your estimated retirement date is farther away, since your assets would have more time to recover from short-term market fluctuations.

Choose a mix of mutual funds. Most mutual funds hold a highly-diversified portfolio of stocks from many different companies, chosen to reflect different investment objectives. Different mutual funds invest in different types of securities, and they also have different levels of risk, so that investors can choose funds appropriate for their goals. Selecting a mix of mutual funds allows you to take advantage of the built-in diversification within each fund as well as additional diversification among funds that have different objectives and strategies.

Consider the funds' market capitalization. Market capitalization refers to size of a company, which is grouped into three main categories: large, mid, and small cap. Typically, large capitalization stocks are generally less risky than mid and small capitalization stocks. If you have a low tolerance for risk, you may want to reduce the amount you have invested in small cap, since small cap stocks tend to fluctuate more than mid or large cap stocks.

Review the funds' investment style. Two common types of investment styles are growth and value. Basically, growth investors seek fast-growing companies and value investors look for bargains. Having a balanced portfolio between these two styles can help protect your assets from market volatility.

Diversification is a safeguard that will help keep your portfolio invested in a way that aligns with your goals. You can choose mutual funds that are right for you by looking at their objectives and investment strategies, which are found in each fund's prospectus. Focusing on your long-term goals and choosing a range of different investments can help protect your assets from — and help you feel more prepared for — short-term market ups and downs.