Portfolio Diversification

Sep 25, 2025

You've heard the expression, "Don't put all your eggs in one basket." The reason is that if the basket falls, you could lose everything in one fell swoop. But if your eggs are in multiple baskets, you have a much better chance of getting home safely with enough eggs to make that omelet. The same principle applies to your investment portfolio.

Keeping all your money in one basket, whether that's stocks, bonds, or real estate, exposes you to the risk of losing more during a market downturn or geopolitical event. A diversified portfolio, on the other hand, spreads your money across multiple investments. If one drops in value, the others can help offset the losses and stabilize your portfolio. Diversification is one of the most fundamental strategies for building an investment portfolio focused on long-term growth.

What's diversification?

Rather than trying to pick potential winners and avoid potential losers, diversification calls for owning a piece of the entire market to increase your chances of long-term success. As the saying goes, "If you can't find the needle, buy the haystack."

Diversification helps lower your overall investment risk by tapping into a concept known as correlation. Correlation is used to show how different investments move compared with one another. When you combine investments that don't move in the same way, your portfolio has low correlation, which can protect against extreme declines. For example, when stock prices fall, bonds typically (but not always) go up. By owning both, you can reduce big swings in your portfolio's value.

So how can you diversify your portfolio? True diversification involves owning stocks from various industries, countries, and risk profiles. It also means investing in other asset classes beyond equities, such as bonds, commodities, and real estate, whose performance isn't usually in sync with stocks during different market environments. These assets work together to reduce a portfolio's overall risk and volatility.

How does diversification work?

Diversification applies to both the stock and bond portions of a portfolio. On the stock side, it means owning shares of U.S. and international companies of different sizes and in different sectors. Bond funds are composed of government bonds, corporate bonds, and municipal bonds, among others.

Having a balance of lower-risk assets like bonds and higher-risk assets like stocks allows a portfolio to grow while providing a cushion against volatility. While stocks offer higher expected returns over the long run, they can experience substantial short-term swings. High-quality bonds, on the other hand, tend to generate lower returns but may provide stability. A diversified portfolio reduces overall risk while still allowing for long-term growth potential. Of course, a diversified portfolio approach may underperform relative to a winning investment, but it may provide stability and can help you sleep at night.

Market factors have changed the dynamics of bond investing and how investors should approach using bonds for portfolio diversification. Higher rates in recent years have created short-term challenges for existing bondholders.

While the bond market has faced headwinds, owning fixed income investments is still an important part of portfolio diversification because these assets may offer stability and can reduce volatility. Bonds generally offer fairly reliable returns and are better suited for risk-averse investors.

What are the benefits of portfolio diversification?

We've all heard stories about the great-grandparent who bought a share of Coca-Cola stock in the 1920s and went on to create generations of multimillionaires. But what about the great-grandparent who bought the stock of a company that went bankrupt or fell victim to new technology or rising competition? For every wildly successful investment, there are many more duds that fizzle out. It's just as easy to pick a loser as it is to pick a winner. That's why diversification is so important. It allows you to simply be in the market without worrying about finding winners and losers.

Diversification helps you reduce the risk of investing everything in a company that goes under by buying hundreds or thousands of securities at a time. In general, diversification is more about risk management than maximizing returns, aiming to reduce the volatility and potential losses in a portfolio rather than hindering or boosting returns.

"Sounds great," you might say to yourself, "but where am I going to get the money for thousands of investments and the time to research them?" Luckily, that's exactly what mutual funds and ETFs are designed for. As an investor, you can simply buy shares of the fund itself and, in turn, gain instant diversification because both investments are professionally managed collections (or "baskets") of individual stocks or bonds.

How do you build a diversified portfolio?

Building a diversified portfolio involves spreading your investments across different asset classes, sectors, and geographies and using different investment styles. Keep these things in mind as you create a diversified portfolio:

Asset allocation:

A diversified portfolio starts with the understanding that you'll have a variety of asset classes. The percentage you invest in each asset class depends on your risk tolerance, time horizon, and goals. Here are three commonly used allocation strategies that reflect varying levels of risk and return:

Aggressive – 80% stocks/20% bonds
Moderate – 60% stocks/40% bonds
Conservative – 40% stocks/60% bonds

A higher stock allocation may provide more growth potential but also greater volatility, while a higher allocation of bonds may increase stability but may dampen long-term returns.

Diversify within asset classes

Market capitalization. Include large-, mid-, and small-cap companies.
Sectors. Spread your investments across various industries like technology, health care, energy, and financials.
Geographic regions. Invest in both domestic and international markets, including developed and emerging economies.
Investment styles. Balance between growth stocks and value stocks.

For bonds, consider a mix of Treasury, corporate, and municipal bonds.

This multifaceted approach to diversification within each asset class helps ensure your portfolio isn't overly dependent on any single performance factor. It can provide more consistent returns across different market conditions and economic cycles.

Alternative investments.

Adding assets like real estate or commodities can further diversify your portfolio.

Mutual funds and ETFs.

Both funds give you access to a wide variety of U.S. and international stocks and bonds. You can invest broadly (e.g., a total market fund) or narrowly (e.g., a high-dividend stock fund or a sector fund)—or anywhere in between.