by Mark Murphy

Created on: September 20, 2008

Without getting too deep into the mumbo-jumbo jargon of investing, diversifying one's portfolio is a very positive thing. Some may argue that one should find a stock or industry that works and stick with it. On the surface and to the short-sighted, it makes sense, sticking with a winner will bring you money. However, it only takes a brief look into the history of the stock market to open the eyes of any but the most foolish of investors.

Before I continue, I want you to think about mutual funds. A good mutual fund invests in a number of different stock or bonds from different industries, such as finance, technology, or retail. This gives the average investor a chance to purchase shares of a company that they may not have been able to on their own, while providing diversification. In this way, if the technology field suffers some sort of setback, the finance and retail areas will buoy your investment. For example, say you invested heavily in subprime lenders a couple of years ago. With the huge dividends they were paying out, lots of folks were making money. Once the housing bubble hit, those stocks dropped like stones, with several of those companies going out of business entirely. So much for your nest egg. During the same time all this was going on, the oil industry was riding a nice high, right? Ah, so now you're thinking you should have just put all your money into oil instead of mortgage loans. Not so fast, oil is cyclical, meaning during certain seasons it does better than others. Plus there are storms at sea, oil speculators, spills, even pirates! The point being spreading out your assets isn't so much to ensure you make the most money you can, but to help protect you from losing too much of it in a downturn.

Yes, it's true that since its inception the stock market has generally gone up. This doesn't mean that you can still invest in one stock and simply ride out the hard times. There were plenty of investors who tried that when Pan Am went under. As a matter of fact, there are hundreds of businesses that went public then went under, taking their investors with them.
If you have limited finances, spreading your assets may not work for you. If you only have a few hundred dollars, it probably won't make a lot of sense to buy three shares of eight different companies. In a case like this, putting all your eggs in one basket is probably a better idea. I wouldn't make that basket the stock market, however. In this instance I would strongly recommend a good mutual fund with a solid history.

Another problem with diversifying is determining what industries to invest in. Should they be similar, symbiotic, or polar opposites? I can't tell you where to put your hard earned money, but I can tell you to do your research. Snoop around the financial websites and learn as much as you can. Don't ask your pal or your neighbor unless they happen to be rich. If your neighbor was that good with his money, he probably wouldn't be living next to you. No offense, but if you were rich you wouldn't be reading this, would you? With that in mind, seek out the advice of people who know how to use money to make more of it.

Learn more about this author, Mark Murphy.
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