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The Easiest Way to Diversify

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The Easiest Way to Diversify Powered By Docstoc
					by: Emma Snow

It's a phrase you have heard over and over, "diversify your portfolio", but what does it mean to
someone with little or no financial background? The world of stock markets, volatility and
portfolios in general may not be all that familiar. Fortunately, in this day and age there are ways
to diversify that don't require you to be all that savvy when it comes to the stock market. There
are a number of investments to choose from that do most of the diversification work for you.
This article shows the many ways to diversify your portfolio, going from the most difficult to the
easiest.

Most Difficult

If you feel really adventurous, you have lots of free time and loads of cash available, you can
purchase your own individual securities. The only time I would recommend this is if you are
very savvy when it comes to the stock market and you are willing to take the risk. If you fit this
description, I doubt you will be reading this article. The expense involved in each individual
trade (it varies depending on your investment company) makes it difficult to achieve the
diversification necessary without spending a lot. Individual securities are fine if you have money
set aside for that purpose only, but a few individual stocks or bonds isn't probably the best place
to put your entire investment portfolio since this would not be diversified.

Difficult

Currently, mutual funds seem to be the more convenient route when it comes to investing for the
long term. When you invest in a standard mutual fund, you are spreading your money across 50-
1000 different securities without having to buy them individually yourself. The mutual fund
manager takes your money, puts it into the pool with everyone else investing in the fund and
purchases stocks, bonds and fixed-income products for you. While it is much more diversified
than buying individual securities yourself, putting all your money in one mutual fund generally
isn't enough to be diversified. In order to diversify through mutual funds it is best to choose a
variety of mutual funds, those that cover large, medium and small companies, international
securities, bonds, fixed-income products, and funds that cover different parts of the market such
as technology, healthcare, real-estate, etc. For a beginner, even choosing your own mutual funds
can be a daunting task. If this still seems a little too difficult, read on.

Moderate

For even more simplicity in choosing investments, consider an asset allocation fund. While most
mutual funds spread your money over securities in a certain sector of the market, asset allocation
funds spread it more widely and completely over several different sectors. It is not uncommon
for an asset allocation fund to invest in almost 2000 different stocks, bonds and fixed-income
products where an average mutual fund invests in about 300.

The other nice feature of most asset allocation funds is they often give you the choice of risk
level. If you are nearing retirement and will need your money in the next 10 years, you could
choose an asset allocation fund that is 50-60% in stocks, 40% in bonds, and the rest in fixed-
income. You still have some growth potential, but if the stock market goes south, your bonds
may help to stabilize the account. This can also be a good choice for someone who can't tolerate
much risk, even if they have a long time until retirement.

There are also more aggressive asset allocation funds for those with a longer investment horizon
or those that can tolerate more risk. If you are already retired and are starting to live off savings,
there are conservative asset allocation funds that would be appropriate for these times as well.
The key to success in diversification isn't just investing in different sectors of the market but
making sure your breakdown of stocks and bonds is correct depending on your age and when
you are going to need the money. If you are still unsure what I am talking about, maybe the next
investment option is for your.

Easy

The easiest and most diversified investment comes in the form of all-in-one funds, sometimes
called lifecycle or retirement funds. Where most mutual funds are made up of different stock,
bond and fixed-income securities, all-in-one funds are made up of different mutual funds. For
example, let's look first at a standard mutual fund, the T. Rowe Price Mid-Cap Value Fund
(TRMCX). As of 3/31/2006 it was made up of about 65 different securities, mostly stocks. This
mutual fund bought stock in companies such as Campbell Soup, International Paper, and Intuit,
to name a few. While 65 securities may seem like a lot if you go and try to make that many
purchases on your own, it is still a very limited piece of the market. If you put all your money
into T. Rowe Price Mid-Cap Value Fund, you would not be considered diversified.

Now let's look at an all-in-one fund, this time from Fidelity, the Freedom 2040 fund. Right now,
this fund is mostly in stocks. It is meant for individuals who are looking to retire around the year
2040. As of 3/31/2006 it was made up of 23 different mutual funds. The combination of all 23
mutual funds ends up being over 4000 stocks, bonds and fixed-income products. These 4000
securities cover all areas of the stock market including mutual funds such as Fidelity Small Cap
Growth Fund, Fidelity Overseas Fund and Fidelity Blue Chip Growth Fund, each of which invest
in very different types of stocks. If you put all your money in the Fidelity Freedom 2040 fund
you would be diversified.

The other nice feature of all-in-one funds is that they become less aggressive as you age. They
are working toward a specific timeline and gradually have less and less in stocks as you get
closer to retirement. This is probably the best feature for less savvy investors. Even the asset
allocation funds spoken of above need to be adjusted here and there so that they are more in line
with your retirement goal. This would mean taking money out of a more risky asset allocation
fund and placing it in a less risky option as you near retirement age. It is possible; it just takes
more work from you. All-in-one funds do this work for you.

While it would be nice to have the easiest route also be the one that pays the highest yield, there
is no guarantee of that. Any of the above options could end up having the highest return
depending on the securities or mutual funds chosen and how they perform. When it comes to
investing, there are no guarantees except this one...not diversifying will almost always hurt you
in the long run. Diversification is the key to any good investment strategy. Now it is just a
question of how you will go about it.

This article was posted on October 23, 2006

				
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