Why Portfolio Diversification Matters & How to do it

A look at how to build a diversified portfolio.

By Matthew DiLallo – Updated Sep 9, 2024 at 11:44 AM

Key Points

Invest in at least 25 stocks from various industries or an index fund for quick diversification.
Include fixed-income assets like bonds to lower volatility and reduce risk in your portfolio.
Add real estate through REITs to potentially increase returns and further reduce portfolio volatility.

Most people have heard the old saying, "Don't put all your eggs in one basket." The logic: If a farmer were to stumble while bringing the basket of eggs back from the henhouse, they could end up with a messy situation. Those words of wisdom go well beyond farming; they also perfectly encapsulate the idea of not risking all your money on a single investment.

One way investors can reduce their risk of a cracked nest egg is by diversifying their portfolio. Here's a look at what that means, as well as three tips to help you quickly diversify your investments.

Loading paragraph...

A hypothetical example of a diversified portfolio that invests in a variety of industries, countries and market caps. — Image source: The Motley Fool.

Loading image...

Loading paragraph...

Stock

A stock represents an ownership interest in a business. When a business wants to raise money, its board of directors determines the number of shares to issue.

Loading paragraph...

2. Put a portion of your portfolio into fixed income

Another important step in diversifying a portfolio is to invest some capital in fixed-income assets like bonds. While this will reduce a portfolio's overall returns, it will also lessen the overall risk profile and volatility. Here's a look at some historical risk-return data on a variety of portfolio allocation models:

Loading paragraph...

Data source: Vanguard. Return data from 1926 to 2021.

Loading table...

Although adding some bonds reduces a portfolio's average annual rate of return, it also tends to mute the loss in the worst year and cut down on the number of years with a loss.

While picking bonds can be even more daunting than selecting stocks, there are easy ways to get some fixed-income exposure. One of them is to buy a bond-focused exchange-traded fund (ETF).

Loading paragraph...

Related investing topics

Loading paragraph...

Accounts That Earn Compounding Interest

Interest compounds when interest payments also earn interest. Learn how to get compounding interest working for your portfolio.

How to Invest in ETFs for Beginners

Exchange-traded funds let an investor buy many stocks and bonds at once in a single transaction.

How to Research Stocks

Good research can help investors find the best companies to invest in.

Loading hub_pages...

Loading paragraph...

Loading faq...

About the Author

Matt DiLallo has been a contributing Motley Fool stock market analyst specializing in covering dividend-paying companies, particularly in the energy and REIT sectors, since 2012. He also covers pre-IPO companies, ETFs, and other investing topics. He holds an MBA from Liberty University.

TMFmd19

@MatthewDiLallo

The Motley Fool has a disclosure policy.