The old adage, "Don't put all your eggs in one basket," isn't just a cliché. Diversification is a time-tested strategy for managing investment risk. Learn what it is and how to do it.

		What is diversification?
		The benefits of diversification
		Different ways to diversify
		Mutual funds-the easiest way to diversify

What is diversification?

Simply put, diversification means choosing several baskets for your investment eggs. Sure, you could hit it big during good times by investing solely in one stock or sector. But this strategy can be devastating if the market goes south and leaves you with a basket of broken eggs.

Diversification is a little like buying insurance. By investing in multiple asset categories-stocks, bonds, cash and real estate to name a few-you're less likely to get hurt if one fares poorly.

The benefits of diversification

Look no further than stock market returns over the last 30 years (1978-2007) to see the benefits of diversification. If you bought just one stock in 1978, say IBM, you'd have had negative returns in 10 of those years.

By contrast, if you'd invested in large company stocks as represented by the Standard & Poor's 500 Index, you'd have experienced negative returns in only 5 years. While IBM is part of the S&P 500 Index, some of the 499 other stocks were in positive territory while IBM was down.

Build your own diversification chart

In the following chart, the blue line represents a single stock-IBM. Click the 100% diversified stocks button to see the difference in volatility and return between this one stock and a diversified stock portfolio.

Add additional diversification by clicking the 60% stocks & 40% bonds button. The 30-year average annual returns may surprise you.

		Diversification Lower volatility with strong returns
		vs and/or
		Source: Morningstar Workstation and Bloomberg 12/07, in USD. Annual returns for one stock (IBM), 100% stocks (Standard & Poor's 500 Index), and a 60% stocks/40% bonds portfolio (Standard & Poor's 500 Index and Lehman Brothers Aggregate Bond Index). Indexes are unmanaged, and you can't invest in them directly. They reflect past results and are not predictive of any particular fund's past or future results.

Different ways to diversify

It can be a good idea to diversify within an asset category, across asset categories and outside Singapore.

Diversifying within an asset category. One risk you can reduce by diversifying is the risk that a specific security will do poorly. You do this by purchasing many bonds, for example, instead of one or two.

You're not really diversified, however, if all those bonds are municipal bonds from the state you live in. Diversification means owning different types of bonds-long term, short term, government, corporate and possibly high yield.

Diversifying among asset categories. The next risk you reduce by diversifying is the risk that an entire asset category, such as stocks, will do poorly for an extended period of time. You reduce this risk by selecting several asset categories-stocks, bonds, cash and real estate, for example.

Diversifying outside your own country. Another risk you can reduce by diversifying is the risk that the domestic financial markets suffer an extended bear market. While there are additional risks with global investing, such as currency fluctuations, diversifying outside the your own country can decrease overall portfolio volatility.

In addition, this will also diversify your overall risk. Do bear in mind that your job and local property are tied to the domestic economy; a sluggish domestic economy would affect not only the performance of your localised assets such as equities and property, but also your own job, in terms of prospects and security.

Mutual funds-the easiest way to diversify

Many people simply don't have enough money to invest in a broad array of individual stocks, bonds and other assets, much less the time and energy to research and monitor them. For these investors, mutual funds may represent the most sensible option.

Mutual funds are by definition diversified. A single fund can hold securities from hundreds of issuers. Mutual funds allow you to easily and cost-effectively invest within asset categories, across asset categories and outside your home country.