Diversification between different stocks and between stocks and bonds is one of the foundational and universally accepted rules behind portfolio theory.
Essentially, it goes like this: If you buy one stock that goes up 10% or down 10% you have a volatile investment that can vary by 20% over time. Alternatively, if you own two stocks and one goes up by 10% while the other declines by 10%, you essentially have not lost or gained anything. So, if you goal is to maximize your return and minimize your risk you should invest in a broad portfolio of stocks (or as I advocate) mutual funds across multiple asset classes.
Portfolio diversification, however, is just the beginning and perhaps the easiest diversification to achieve. As part of every financial plan, I advocate diversification across all aspects of my client’s financial lives.
For example, if you work for a bank do not invest heavily in bank stocks. Similarly, if you have all your bank accounts at Chase, you may also want to have one at Bank of America, and thereby diversify (and extend) your access to ATM ‘s, credit cards and other financial products (it also provides protection in the unlikely event a bank’s systems are interrupted).
If you travel (especially internationally) and you rely on using a credit card, you may want to have a Visa and a Discover, if one is not accept. You may also want to carry an ATM or debit card, so you have ready access to cash. When I travel, I will carry one set of cards and my wife will carry another.
Computer data, both work related and personal, can be irreplaceable, so make an electronic copy. Store a copy on your computer and back up a second copy in the cloud through an internet data service . And what about internet access, my work depends upon access to the internet so I use WOW at home, Comcast at my office and carry a Sprint hotspot.
In life, there are many risks. Some we see every day as in stock market volatility. Other, we may only experience once in a life time, like a major weather calamity (think major snow storm, hurricane or flood), the loss of a job or the risk of a malicious computer virus. So, I advocate diversification as the fundamental first step in risk management.