Routinely Today... Investment Diversification Is Far Too Readily Accepted As Merely Meaning Diversity Across Asset Classes.
This limited concept of investment diversification is much too simplistic.
If you ask most anyone what investment diversification means to them...
They will likely say... being invested partially in stocks, partially in bonds, and partially in cash securities.
Many individuals... and probably many investment advisers... go no further than the broad asset classes (stocks, bonds, cash) when considering diversification. While investment across the broad asset classes is important...
It should not be considered to be "good enough" when it comes to portfolio investment diversification.
True and full investment diversification cannot be assured by merely focusing on the broad asset classes.
You must look deeper!
That said... let's turn to the broad asset classes.
An asset class is defined as...
A class or category of investments that have similar characteristics... including risk factors and how returns are created.
The most common asset classes are... stocks, bonds, real estate, precious metals, and cash.
And... of that group... Stocks, bonds, and cash make up what is very often referred to as... the broad asset classes or broad investment categories.
Each asset class has different qualities and strengths... as well as risk and reward characteristics.
Knowing how the three main asset classes differ is important to choosing the right investment strategy for your own needs.
Be aware that... the general term "securities" is often used to describe these investment products.
Securities are... transferable certificates of ownership of stocks, bonds, and other investment products.
Here is a closer look at each of the broad asset classes... the major types of each class... and the major reasons to choose each for your portfolio.
Stocks — Stocks (also called equities) are units of ownership in a company. When you buy a share of stock of a company... you are buying a unit of ownership in that company. Shares earn or lose money based on the increasing or decreasing share value.
The major types of stocks are:
- Common, Preferred
- Large Cap, Mid Cap, Small Cap
- Growth, Value
- International, Domestic
The major reasons to invest in stocks are:
- High return potential
- May provide income
- Long term horizon
Bonds — Bonds represent money loaned to the issuer (governments, municipalities, other entities) by the investor. Bond investors earn money from the interest paid on that loan. Bonds are also called fixed-income investments.
The major types of bonds are:
- Government, Agency
- Mortgage-backed, Asset-backed
- International, Domestic
The major reasons to invest in bonds are:
- Regular income
- Potential for price appreciation
- Possible tax advantages
Cash — Treasury bills, certificates of deposit (CDs) and other short-term securities are called cash or cash equivalents. They earn money through interest, which is generally set at a guaranteed rate.
The major types of cash securities are:
- Treasury Bills
- Commercial Paper
- CD's and Bankers Acceptances
- Money Markets
The major reasons to invest in cash securites are:
- Regular income
- Relative price stability
As you can see... each asset class has different levels of potential risk and reward which... when combined together... can help create a diversified and well balanced investment portfolio.
Most investing information rightly makes the case for investment diversification... by advocating the creation of... an asset allocation utilizing the broad asset classes.
However... I repeat... true and full investment diversification cannot be assured by focusing only on the broad asset classes. Diversification across the Broad Asset Classes represents...
merely one way... in which you should be diversified.
A truly diversified investment portfolio
must be diversified in several additional ways.
Broad investment diversification can have a significant impact on your ability to reach your investment goals.
Make sure you are truly diversified!
"Because It Matters"... Jim
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