Old sayings are often still relevant (which explains why they’ve been around so long). Take the saying "Don’t put all your eggs in one basket." It’s good advice, because if you drop the basket, you’ll break all your eggs. But, if you divide your eggs between several different baskets and one of them drops, only some eggs will break.
This old saying about eggs and baskets helps to explain an investment strategy called diversification. Diversification is the investment strategy of putting your money (eggs) into several different investments (baskets). It also is an effective way to manage investment risk.
Don’t Get "Fried"
The stock market is volatile. Mergers, inflation, and other economic developments can send stock prices soaring or plummeting on any given trading day. If you put all of your retirement money into one single stock investment, you could suffer a large loss if that stock is a dud.
"Scramble" It Up
Investing in more than one security reduces the chance that you’ll suffer an overall loss when the value of one security declines sharply. When you put your retirement savings in a stock portfolio, you are automatically diversifying. The portfolio pools your money with that of other investors and buys the stock of numerous companies.
If the portfolio invests in companies from different industries, your investment is even more diversified. It is not unusual for one sector to experience sharp losses while other sectors remain stable.
Putting your money in different types of investments helps you diversify even further. For example, you might include bond and money market portfolios in your investment mix. Diversification across asset classes can be a very effective tool in managing risk.
Choosing Your "Baskets"
How you allocate your investment assets depends on your risk tolerance and the number of years until you will need the money. Stocks provide potentially higher returns but involve a greater risk of loss. Bonds offer lower risk but lower potential returns. And although there is little chance of losing your investment principal with cash equivalent investments (such as money market securities), you run the chance of not keeping up with inflation because returns may be lower than the inflation rate.
In general, the longer you have before you retire, the more risk you can tolerate.
Close Window