Introduction to Diversification
Diversification means splitting your money among several investment options, so that if one option you choose does poorly your entire investment won't suffer the same fate.
Suppose you invest all your money in a single stock: Intel Corp., for example. Your entire investment will be wrapped up in that company's performance. The return on your investment will depend on internal factors such as how well the company's products do, how successful its R&D (research and development) is, and what personnel changes it makes, not to mention external factors such as how well the microprocessor industry as a whole performs. Intel is a great company, but nobody's perfect, and every downturn in Intel's fortunes will affect your entire investment.
If on the other hand, you put part of your investment into Intel, and part into Mobil
Corporation, you will significantly reduce your reliance on either investment. During
periods when Mobil -- or the petroleum industry overall -- is doing poorly, Intel may
be doing well, and vice versa. You will have reduced your exposure (vulnerability) to the risks both of the
individual companies and their respective industry sectors. Your investment account
will be more versatile than it would be with a 100% weighting (entire investment) in any single stock.
You can continue to add other stocks to your portfolio, further spreading out your exposure
to company-specific risk. Although there may be times when the whole economy declines,
affecting all of your investments, diversification across a broad spectrum of
industries will generally help protect your investment.
Proper asset allocation -- having investments that balance each other out in terms of performance -- can actually help you make more money. There is a whole world of investments out there, and a diversified account gives you the versatility to play in a number of fields with a substantial degree of safety.