The Importance of Diversification

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In the world of personal finance and investing, the word you’ve probably heard more often than any other is “diversification.” If it sounds complicated, don’t worry, because it’s not…

“Don’t put all your eggs in one basket”

In terms of buying stocks and other types of investments, diversification is just a fancy way of saying “Don’t put all your eggs in one basket.” In theory, if you spread out your money amongst several different types of investments (stocks, bonds, real estate, etc) you are also spreading (limiting) the overall risk. Here’s an example…

With this diversification strategy, a big loss in any one investment doesn’t necessarily destroy your entire portfolio of investments (because you wisely invested in a diverse group of things). For example, if a stock you invested in takes a nosedive, that shouldn’t have any impact on the investment property you are renting out for a second source of income.

If you purchased 100 shares of Apple at $190 and the price per share dipped to $180 (a loss of $1,000) — that shouldn’t have any impact on the value of your investment property. Once again, the principle here is to avoid a situation where a dip in one investment is likely to signal a dip in other investments. The share price of Apple and the value of your home are not correlated.

Consider real estate

It should be noted, the example above is not commonly used when discussing diversification. Most conversations regarding diversification only mention different “asset classes” such as stocks, bonds, commodities, mutual funds and ETFs. Rarely is real estate brought into the conversation due to the higher purchase price. However, depending on the housing market in your local area (cost of living, affordability, supply/demand, etc) real estate might be a realistic opportunity.

After all, if you want to buy one single share in some of the largest companies, you’ll end up spending more than most pay for a mortgage payment! Amazon ($1,700), Alphabet ($1,160), Netflix ($420).

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Sam Cooper

Sam Cooper

Spent 10+ years in corporate finance before I realized how much more I enjoyed writing and advising people on how to achieve financial freedom. We all have different goals, what are yours?

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