From Here to Financial Happiness

Day Fifty Eight Spreading Your Bets

Once you settle on your asset allocation for any particular goal, the next step is to diversify – and that means buying lots and lots of securities.

Admittedly, this isn't so important with cash investments. If you have a money market mutual fund, there isn't a strong diversification argument for opening a high‐yield savings account. Instead, diversification matters most with bonds, alternative investments, and stocks.

Let's say you own shares in just one company. What if that company gets into financial trouble? There's every chance you'll lose much or all of your investment, no matter how well the rest of the stock market is performing. You'll have taken a massive amount of risk – making a big bet on a single company – and yet have nothing to show for it.

To avoid that fate, you need to own lots of stocks – big and small, US and foreign. Similarly, you'll want to own lots of different bonds and, if you opt to invest in alternative investments, you should buy many different securities. By diversifying broadly, you reduce the risk of owning any particular stock or bond, and you are far more likely to be rewarded for the risk you're taking. In other words, if you are diversified and the financial markets rise over time, your portfolio will almost certainly go along for the ride.

Buying so many stocks and bonds might sound daunting. In truth, it's remarkably easy – thanks to mutual funds and exchange‐traded index funds. Funds simply bundle ...