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One of the most important concepts of investment education is that of diversification. In my Investing 101 course I equate diversification to allocated spending for a new wardrobe. This incredibly simple concept is one of the best ways to reduce risk in your investment portfolio. Like many areas of my life I am finding that the most important concepts are the simplest yet often the hardest to implement.
Let’s take a simple example. If you decide to spend $5 000 on a new fall wardrobe would you spend $ $4 500 or 90% of that money on a new designer handbag? Of course not you would allocate a reasonable amount of your total available resources and choose a purse in that price range. In the same way you would not allocate 90% of your total investment capital to one stock. Instead you would divide the total among various types of investment categories. By diversifying your portfolio in this way one of your investments is more likely to increase while another decreases or at least hold the same value thereby reducing your overall risk.