Diversification in Mutual Funds
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Diversification in Mutual Funds
Diversification in investing means acquiring securities with assets that are unrelated to one another.
Things To Know
- Diversification is built in to mutual funds.
- Diversification spreads investment risk.
About diversification
For instance, a diversified stock portfolio might include technology, food service, and petroleum industry stocks. The products and markets of these companies are generally unrelated enough that no one economic factor—like a drop in oil prices, for instance—should have a dramatic effect on the performance of the entire portfolio.
It is not easy to design a diversified portfolio. First, there is the time-consuming task of weighing and balancing the risks of each investment you include in your portfolio. You also need sufficient capital to purchase the broad scope of investments needed in sufficient quantities to take advantage of low transaction costs.
A built-in feature
Diversification is built in to mutual funds. Mutual funds collect money from many investors, pool it, and then buy different securities. These investments may include stocks, bonds, money market instruments, and derivatives. How much of each type of investment a fund buys depends on what the fund’s objective is. If the objective is growth, the fund may choose more stocks. If it is to pay its shareholders steady income, it may choose bonds and other interest- or dividend-paying securities.
Advantages of diversifying
Diversification lets you spread investment risk over several companies, industries, and types of securities. By investing in different types of securities, you may help reduce the risks inherent in each market. When one market goes down, another may go up. Stocks, bonds, and other assets do not typically rise and fall together. Therefore, when you have several different types of securities within a mutual fund and one of them performs poorly, the effect on the overall portfolio should be less impactful.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Additionally, it should not be assumed that owning a mutual fund alone will achieve the concept of diversification. Be certain to consider the fund’s written objective in relation to your objectives, time horizon, and risk tolerance when you diversify. Diversification does not ensure against market risk.