Diversification with the Mutual Fund: Divide and Conquer

If you are looking for diversification, mutual fund investing is one of the best ways to achieve this. Diversification is an extremely important part of any successful portfolio. Here are a few things to consider about diversification and how mutual funds attempt to achieve it.

Diversification

The idea of the importance of diversifying a portfolio comes from Modern Portfolio Theory. This is a concept that was first developed in the 1950s. The idea behind diversification is that you can lower the overall risk of your portfolio while increasing the possible returns at the same time.

Mutual Funds

Mutual funds were invented with the idea of diversification in mind. Mutual fund managers do their best to choose a variety of securities in order to provide a diversified portfolio for their clients. Most mutual funds will hold hundreds of different stocks, bonds or shares of other mutual funds. Some mutual funds will even purchase precious metals, commodities, and many other things to try to achieve diversification.

Benefit to Investors

By investing in mutual funds, you will be able to take advantage of a situation that can provide you with diversification. Most investors would not be able to invest enough money to create a truly diversified portfolio on their own. Some experts say that you would need at least 100 different stocks from the stock market in order to create a truly diversified portfolio. Not many individuals can afford to put a substantial amount of money into over 100 stocks. However, when you pool your money together with other investors, this concept becomes possible. This is exactly what you are doing when you invest in a mutual fund. Mutual funds take the collective resources of many investors and use them to invest as a single entity. This provides you with economies of scale that you would not be able to get on your own.

Getting through Tough Times

Another benefit that you will receive by investing in mutual funds is the ability to get through tough financial times relatively well. A mutual fund will invest in stocks from many different sectors within the stock market. By doing this, they can effectively help you avoid losing substantial amounts of money in your investment account. Even during tough times, every stock will not go down in value. Therefore, by having a portfolio full of different stocks, you can avoid losing as much money as if you had it invested in a limited number of stocks.

Eliminate Risk of Default

If you were to invest in an individual company, you would always have to worry about the risk of default. If that company went through a downturn in the market, they could potentially lose everything. When this happens, investors in that particular stock will lose their investments. If you have invested in a portfolio that has hundreds of different stocks, the bankruptcy of one company will not hurt you that badly. You will still have the returns from all of the other companies bringing up the portfolio value.

blog comments powered by Disqus
Scottrade