Diversification means investing in a variety of investments. As the saying goes "Don't put all your eggs in one basket." Mutual funds (also referred to as managed funds and unit trusts) are an investment vehicle in themselves so you may be asking the question "How do you diversify when investing in mutual funds?"
Actually mutual funds are a great vehicle for diversification as you can spread your investments within one fund alone. A mutual fund pools the money of investors and distributes the funds according to the type of fund that has been chosen. With small sums of money you are able to achieve diversification very well.
Take for example a Balanced Fund which uses each of the asset classes in percentages appropriate to the current markets. Generally a Balanced Fund has 50% in growth assets such as shares and 50% in more conservative income areas. This is diversification and it can be achieved with as little as $500 in some funds. This spreading of investments is called asset allocation.
Those with larger sums of money can invest in a variety of managed funds applying their own diversification. The example here would be placing a percentage of funds into a share fund, a fixed interest fund, a property funds, a cash fund as well as using a fund specialising in international markets. Once again diversification is achieved.
Not only do you invest in various asset classes to diversify your investments but you need to invest in a number of different assets within that asset class. In the case of shares you will require an investment into different industries as well as holding a number of different shares. If one industry has a bad period other industries may perform well.
With your portfolio spread among several different investments through your managed fund, you benefit when each type is doing well. It also limits exposure when one or more investments are performing poorly. Alone a particular investment may be volatile but placing it with another that performs at different market cycles you average your return and it levels the volatility.
Mutual funds offer the potential for maximizing investment performance, investment flexibility, and convenience. These funds allow you to allocate investments among several asset categories to tailor the mix to suit your needs and they are professionally managed on your behalf.
Being able to diversify when investing in mutual funds is simple, and a great way to invest, particularly for investors with smaller sums of money.