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Principle 3: Stay Diversified


Diversification is your best defense against risk. You should invest in a variety of assets and asset classes. Diversification does not mean investing in ten different banks. It means investing in different companies, industries, and perhaps even countries. Bank stocks will all tend to go up and down together (i.e. they are highly correlated). To truly diversify you need to invest in different industries and perhaps countries that won’t be subject to the same economic factors or risks. Make sure you understand the risks of each of your investments. Investing is risky and uncertain: minimize risk by diversifying your portfolio.


Many people review the portfolio returns from various asset classes over the last ten, twenty, or fifty years to get an idea of an asset class’s performance history. However, these same people often invest in only one or two single assets instead of investing in a portfolio of five hundred or more stocks; they are often disappointed when they do not get the asset class returns they thought they would. Remember, the returns from asset classes are from portfolios of hundreds of assets—not individual assets. To see the effects of diversification, see Learning Tool 23: Return Simulation Worksheet in the Learning Tools directory of this website.


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