A diversified investment is a portfolio of various assets that earns the highest return for the least risk. A typical diversified portfolio has a mixture of stocks, fixed income, and commodities. Diversification works because these assets react differently to the same economic event.
Diversified Strategy
Key Takeaways
- You receive the highest return for the lowest risk with a diversified portfolio.
- For the most diversification, include a mixture of stocks, fixed income, and commodities
- Diversification works because the assets don’t correlate with each other.
- A diversified portfolio is your best defense against a financial crisis.
How Diversification Works
Stocks do well when the economy grows. Investors want the highest returns, so they bid up the price of stocks. They are willing to accept a greater risk of a downturn because they are optimistic about the future.2
Bonds and other fixed income securities do well when the economy slows. Investors are more interested in protecting their holdings in a downturn. They are willing to accept lower returns for that reduction of risk.3