Diversification takes asset allocation deeper by dividing your portfolio into different categories within each asset class. The challenge, however, is to effectively spread out your investments amongst a wide range of companies and industry sectors, concentrating on those that may perform differently under a variety of market conditions.
Having the knowledge and wherewithal to properly diversify your investments is a challenge. This is why, according to the U.S. Securities and Exchange Commission, “some investors may find it easier to diversify within each asset category through the ownership of mutual funds rather than through individual investments from each asset category.”* Some mutual funds may invest in thousands of companies, which, in theory, provide a greater amount of diversification and can help smooth volatility. Diversification does not guarantee a profit or protect against a loss in a declining market.
Would you rather ride in an elevator with just one cord holding it up or in one with multiple cords holding it up? What if a cord were to snap? Although there is no guarantee that a diversified portfolio will outperform a non-diversified portfolio, diversification is an important component of any long-range financial strategy that seeks to reduce risk.