Diversification is the process of selecting different types of investments within an asset class. Over the long term, holding a diversified mix of funds can help decrease risk and increase returns. We all know this strategy as “don’t put your eggs in one basket.”
Diversifying By Geographical Region
International and domestic funds complement each other in a portfolio; markets around the world tend not to move in sync with each other, and economic changes affect every market differently. In addition, non-U.S. countries have products and natural resources that can’t be found — or invested in — domestically. Since more than half of the world’s investments are outside the U.S. holding both international and domestic funds helps ensure that portfolio performance isn’t dependent on market performance in just one part of the globe.
Diversifying By Time Horizon
You can also diversify your portfolio by time horizon. For example, long-term bond funds typically hold bonds that mature in 10 years or more, while short-term bond funds typically hold bonds with maturities of one to five years. By investing in funds that hold bonds with different maturities, you spread the risk and increase the potential return of this portion of your investment portfolio.
Diversifying By Investment Style
Stock funds are available in a variety of investment styles: Large-cap funds invest in companies with a total share value of $10 billion or more, while small-cap funds invest in companies with a total share value between $300 million and $2 billion. Growth funds hold stocks of companies that typically outperform the market; value funds hold stocks of companies that are undervalued by the market. Since each investment style has different degrees of potential risk and return, including a mix of styles in your portfolio helps to keep your overall mix of both in balance.
Source: VALIC Retirement Essentials, Fall, 2014
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