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| Diversifying With Individual Investments |
| You can reduce risk and volatility (large fluctuations in returns from one period to the next) by investing in different types of securities–such as stocks, bonds, and cash. The reason you want to do this is that different types of securities don't always move in the same direction at the same time. When one zigs the other zags. This helps smooth out your returns over time and should make your returns more consistent. Within each asset type, you can diversify among various sub-asset classes, geographic regions, and capitalization levels, as well as investment styles. |
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| When you want to reduce or increase risk in your portfolio, you should consider the total performance of your investment account. Many investment professionals advise investors not to dwell too much on the riskiness of a specific stock or bond; rather, they should think about how the addition of that individual security will impact the portfolio's overall risk/return profile. |
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| Risk is defined as the chance that an investment won't perform as expected and the investor will lose money. Usually, the greater the risk an investor is willing to assume, the greater the potential for higher returns. The risk of an entire portfolio can be derived mathematically and depends on two factors–the risk of each individual investment and the correlation among the investments. |
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| It is that second factor that many investors overlook when determining their risk exposure. |
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| When two assets are positively correlated, they respond the same way to market movements and events. When they are negatively correlated, they move in opposite directions. This "zig-zag" effect allows you to balance your investments, so that one investment, in theory, will always be rising when another is falling (in practice, securities don't move so neatly or predictably). |
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| So, remember this crucial point when you are shaping your investment portfolio: the less your assets move together, the better off you will be. |
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