Why Investors Diversify: Spreading Your Wealth Across Assets, Industries and Countries

Putting hard-earned money into the stock market can be a scary move for first-time investors. Unlike a bank account, where you basically know that you’ll get interest -- a small, but guaranteed return on your cash -- buying stock gives you the opportunity to make a lot of money, or lose your entire investment. Diversification, or investing in a variety of different options, can help you balance any losses in one area with gains in another. Read More

by Marty Daks

Julie Yoon has learned that doing some careful research and spreading your investments across a number of stocks in the stock market, instead of putting everything into one or two companies, can boost your chances of investment success. “The stock market is a way to make money if you are careful,” says Yoon, a senior at Plano West Senior High, in Plano, Tex. She should know: In a stock competition sponsored by the University of Texas at Dallas, she turned a $1 million virtual, or imaginary, investment into nearly $1.3 million in just three months.

Variety: A Smart Strategy

Industry diversification was an “important part” of Yoon’s strategy. “If I had only purchased stocks relating to technology, for instance, I might have lost all of my money during July [2011], when the stock market was at its lowest” and tech stocks, among others, took a hit, she says.

Diversification means that an investor should buy investments that are not concentrated in one company, industry, country or even type of asset. When it comes to the broader practice of putting your money into different investment vehicles, the idea is to “include different assets in your portfolio,” according to Charles Rotblut, vice president of the American Association of Individual Investors and editor of the AAII Journal.

“You may not be able to always accurately predict the performance of a single asset, but if you’ve got a variety of assets [such as stocks, bonds and certificates of deposit (a cash equivalent that has a guaranteed rate of profit)], you’ve got a better chance,” he says. “You could just buy a lottery ticket, for example, but if you don’t win, you’re out the dollar or so that you spent. But by investing in a broad way, you may lose out on some parts of your investment, but you could still have growth in other segments.”

If you are focusing your investing on stocks, it can be important to also diversify by industry. Yoon spread her money across eight stocks that she chose after careful research. “Since there are so many different stocks in the economy, I always found it best to stick to only a few,” Yoon says. “If you move from stock to stock constantly, you may think that you are gaining money, but in reality, you sacrifice a lot more money” since you’re likely to rack up brokerage fees, and because it’s very difficult to always time your sells and buys in a way that catches the market’s highs and lows.

Early on, she selected companies like Bank of America, Google and Johnson & Johnson, representing the banking, technology and health care sectors, respectively. “I chose these stocks because I had found positive information and thought there was a good chance they were going to be successful during the summer,” she notes.

But when the stock market fell, she chose some “Trading-Inverse Equity” funds, like Direxion Financial Bear 3X, which were designed to move against the flow of the market, which at that time was suffering. “These stocks moved in the opposite direction the stock market moved,” Yoon says. “So when the stock market was going down, these stocks would be increasing at an incredible rate. I researched my stock picks by looking at the stocks that economists and other professionals thought would do well. I also used a free virtual trading website to look at what stocks virtual traders around the world were purchasing.”

Bad News Can ‘Drag You Down’

Yoon had a lot of virtual dollars to invest, but when it comes to playing the market with actual cash, teen investors usually have a small amount of discretionary funds, or extra money. Rotblut suggests they consider investing in a mutual fund (a group of investors operating through a fund manager to purchase a diverse portfolio of stocks or bonds), or an exchange-traded fund, which is a stock-like investment fund that is traded on an exchange. “ETFs and mutual funds can give you a broad portfolio even if you have only a small amount to invest,” he says. “If small investors try to buy the stocks outright, they may be over-concentrated, and some bad news from one company could drag them down.”

Besides investing in different companies, Rotblut says investors should also look at different countries. “Some ETFs and mutual funds hold shares in companies that are scattered across the globe, or are in emerging markets like China and Brazil” that are going through rapid growth and industrialization, he says. “Think of it like making a meal. The more ingredients you use, the tastier it’s likely to be.”

Yoon says she learned a lot from the stock market competition, and plans to do some investing with her own money. “I actually did not know anything about the stock market before I got involved with the program,” she notes. “However, after becoming involved, I borrowed books and learned more. I do plan on investing in the stock market in the future. I find it very exciting to be a part of the economy on a broad level.”

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Conversation Starters

What does it mean to diversify your investments?

Why is it important to diversify by industry if you are investing in stocks? If you love the oil sector, why not invest in six different oil companies?

Why might it make sense to invest in assets related to an emerging economy like Brazil?

2 comments on “Why Investors Diversify: Spreading Your Wealth Across Assets, Industries and Countries

  1. To diversify your investments means to invest in multiple different sectors of the economy.

    It is important that we diversify by industry because all industries have highs and lows at different times. If you love the oil sector and invest in six different oil companies instead of diversifying, you can accumulate a lot of losses if the oil sector goes into one of its lows. If you would have diversified, only one of your stocks would have gone into losses and the others would be functioning fine.

    Emerging economies have a lot of growth potential and show promises of high returns, usually associated with high risks, compared to developed economies.

  2. By not putting all your eggs in one basket, you’re less vulnerable if a particular company, industry, or even country performs poorly [1]. Diversification helps you weather economic downturns.

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