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What is Diversification?

The goal of diversification is to lower the risk and improve your returns in your overall portfolio by investing in different types of assets that are more likely to have different risk and return profiles.

Simply owning many stocks or mutual funds will not necessarily achieve diversification. To be diversified, the key is to select asset classes that are unlikely to experience similar price movements. While there are many different asset classes, the most common include large, mid and small company stocks, corporate and government bonds, alternative investments and cash.

Historically, stocks have outperformed other asset classes such as bonds and money market funds, but have also experienced the most risk, or volatility. Cash instruments such as CDs or money market funds typically have much lower returns but significantly lower volatility or even none at all.

Risk return profiles of common asset classes

The importance of portfolio diversification is that performance of any one segment of the market is impossible to predict. Utilizing a number of different asset classes may help avoid significant declines to your overall portfolio if any one asset class performs poorly in the short term.

Jemma Everyday Wisdom: Diversification is an important tool that can help you reduce risk and improve your overall returns so you can reach your long-term financial goals.

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