8. Building an Investment Portfolio
Continuing with the “many baskets” idea, studies have shown that over long periods of time, one can get a better return with the same amount of risk by “diversifying” the portfolio. For stock or bond investments, this means you should have enough different companies in your portfolio so that if one company does really poorly, it will not significantly hurt your total investment. This is called “company-specific” risk. However, if the whole market does badly, diversification will not work. This “market risk” cannot be diversified away. That’s when you will be glad to have invested some of your portfolio in less risky assets like bonds!
Since most people do not have the time or resources to invest in 30 different companies, mutual funds are a great way to diversify your portfolio. You can rely on the mutual fund manager to help with that. An index fund, which follows the market index trends may also help accomplish this diversification.