Don't put all your eggs in one basket. Just about everyone has heard this trite piece of investing advice.
This phrase refers to the need to diversify investments, and even the most novice investor has been told to diversify his or her portfolio to reduce risk. Many take this to mean that they should buy many different stocks or use mutual funds. Unfortunately, that interpretation of diversification didn't help investors very much in the recent downturn. All stocks fell substantially, and those who thought they had less risky portfolios due to diversification often lost just as much as those who hadn't diversified at all.

What gives? The painful lesson is that all stocks are eggs and the stock market as a whole represents a basket. Doesn't sound very diversified, does it?

About Eggs and Nests
To be more technical about it, the key to understanding why nearly everyone lost money in this market downturn - whether diversified or not - is found in the difference between systematic risk and unsystematic risk. Systematic risk is the risk that the entire asset class will move together. This can't be avoided. Unsystematic risk is the risk that one stock will move independently of all others, either good or bad. This can be avoided by owning several different stocks. (To learn more, read Risk and Diversification: Different Types Of Risk.)

So how can you protect your portfolio from both types of risk? Here are three tips that will help make your portfolio truly diversified.

  1. Don't Be Bound by Class
    Decide on the best asset allocation for you. In doing so, you should consider at least three different asset classes - stocks, bonds and cash - when developing your overall portfolio. When making this decision, recognize that stocks have the highest potential return, but also will lose the most in a downturn. Bonds are less risky, but also provide a lower return. Cash, such as a savings account, is the least risky, but provides very little return. Many investors, even after considering this, will opt for mostly stocks as they need or want that potentially higher return. But even if you end up with an all-stock portfolio, the process of consideration will help you realize that all of your eggs are in one basket and that you had better handle it carefully.
  2. Think Outside the Basket
    If you want the higher return of stocks, but still want some diversification, consider more advanced types of investments. These could include commodities, real estate investment trusts (REIT's) and foreign currencies. These are more complicated and maybe more risky. While not for novice investors, they are an option that can provide the potential for higher returns and the diversification away from that one basket of stocks.
  3. Focus on the Big Picture.
    As advanced investments are probably beyond most average investors, and the only way to have the potential for higher returns is to put a fairly high percentage of your portfolio in stocks, the only thing that will help is to watch that basket. This means you need to stay focused on the big picture and attuned to the overall situation with the market and the economy. Then try to adjust your portfolio when times start to look gloomy. This is very difficult to do, but it's the best chance you have to avoid losses when the entire market falls.

Most people want what they can't have: low risk and high reward. This makes deciding where to put your "eggs" very difficult. Just remember that buying more stocks won't necessarily reduce your risk. "Don't put all your eggs in one basket" is still a sound piece of investment advice - the problem is, many people who believe they're creating a diversified portfolio are really just collecting the ingredients for a larger omelet.

Related Articles
  1. Fundamental Analysis

    The 3 Best Investments When Bull Markets Slow Down

    Find out why no bull market lasts forever, and why investors should shift their assets away from growth and toward dividends when stocks slow down.
  2. Investing

    Retirees: 7 Lessons from 2008 for the Next Crisis

    When the last big market crisis hit, many retirees ran to the sidelines. Next time, there are better ways to manage your portfolio.
  3. Mutual Funds & ETFs

    Top 3 PIMCO Funds for Retirement Diversification in 2016

    Explore analyses of the top three PIMCO funds for 2016 and learn how these funds can be used to create a diversified retirement portfolio.
  4. Economics

    The 2007-08 Financial Crisis In Review

    Subprime lenders began filing for bankruptcy in 2007 -- more than 25 during February and March, alone.
  5. Economics

    Industries That Thrive On Recession

    Recessions are not equally hard on everyone. In fact, there are some industries that even flourish amid the adversity.
  6. Mutual Funds & ETFs

    The 4 Best Lord Abbett Mutual Funds

    Discover the four best mutual funds administered and managed by Lord, Abbett & Co., LLC that offer investors a wide variety of investment strategies.
  7. Investing Basics

    10 Habits Of Successful Real Estate Investors

    Enjoying long-term success in real estate investing requires certain habits. Here are 10 that effective real estate investors share.
  8. Investing Basics

    5 Types of REITs And How To Invest In Them

    Real estate investment trusts are historically one of the best-performing asset classes around. There are many types of REITs available.
  9. Investing Basics

    5 Simple Ways To Invest In Real Estate

    There are many ways to invest in real estate. Here are five of the most popular.
  10. Fundamental Analysis

    5 Basic Financial Ratios And What They Reveal

    Understanding financial ratios can help investors pick strong stocks and build wealth. Here are five to know.
RELATED FAQS
  1. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  2. What is finance?

    "Finance" is a broad term that describes two related activities: the study of how money is managed and the actual process ... Read Full Answer >>
  3. What is the difference between positive and normative economics?

    Positive economics is objective and fact based, while normative economics is subjective and value based. Positive economic ... Read Full Answer >>
  4. How liquid are Vanguard mutual funds?

    The Vanguard mutual fund family is one of the largest and most well-recognized fund family in the financial industry. Its ... Read Full Answer >>
  5. Which mutual funds made money in 2008?

    Out of the 2,800 mutual funds that Morningstar, Inc., the leading provider of independent investment research in North America, ... Read Full Answer >>
  6. How do mutual funds work in India?

    Mutual funds in India work in much the same way as mutual funds in the United States. Like their American counterparts, Indian ... Read Full Answer >>
Hot Definitions
  1. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  2. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  3. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  4. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
  5. Dark Pool Liquidity

    The trading volume created by institutional orders that are unavailable to the public. The bulk of dark pool liquidity is ...
Trading Center