Tuesday, June 9, 2009

What is Diversification?

Have you ever heard some say “don’t put all of your eggs in one basket”? What does that mean? Well, if you put all of your eggs in one basket and that basket drops, you run the risk that all of your eggs will be broken and lost. But if you put a few eggs in two or more baskets and only one basket falls breaking only its eggs, you still have some good eggs in your other baskets that didn’t fall and break.

That is diversification: putting your money in several different places or buying some stocks from several different companies. For example, if you use all of your money to buy stock in only one company and the value of that stock drops then you could lose all of your money. But if you diversify, maybe you buy stock in several different companies and put some money in the bank for saving and keep some money at home in your piggy bank. Then if the value of stock in one company goes down, you only lose the money you invested in that stock but should still have money in your other locations.

By the way: what’s the most you can ever lose in stocks? The amount you invested. What’s the most you can gain? Unlimited – anything can happen.