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Why should I diversify my investments?


The main reason is that no one can predict the future. It’s impossible to know which types of assets – American or foreign stocks, bonds, gold or other commodities, real estate – will perform best during the period that you plan to put your money to work. The prudent thing to do in a world of uncertainty is to spread your money around among several different types of investments, adjusting the proportions to conform to your personal circumstances, such as age, family obligations and risk tolerance, as well as your medium- and long-term views about various investments’ risks and reward potential. That doesn’t apply just to investors of modest means and knowledge about the markets, by the way. Even pros with guru status – the Warren Buffetts of the world – diversify their assets.
Another reason to diversify is the curious alchemy that a blending of assets provides. Academic research has shown that a mix of stocks and bonds, generally in a ratio of 70 to 30, will produce better risk-adjusted returns than either asset class separately. That means that while such a portfolio probably will generate lower returns in the long run than an all-stock portfolio, it will be a small price to pay for the greatly diminished volatility – and therefore enhanced safety – that an investor gets in return. Looking at it by starting at the other end, the mixed portfolio is likely to be more volatile than a bond-only portfolio, but the extra returns should be well worth the bigger swings.
-Conrad de Aenlle