When it comes to your investment portfolio, an important point to keep in mind is to diversify your assets. Don't put all your eggs in one basket!

Diversification means that you have chosen two or more assets that historically have responded differently to the market. With a truly diversified portfolio, you have the potential to achieve the long-term benefit of each asset, while helping to smooth out the overall risk of the portfolio as a whole.

For example, if an investor owned just one stock and that stock's price went down, the value of the entire portfolio would go down. But, if the investor owned several different types of stocks and the price of one went down, hopefully, the price of the other stocks would be enough to help offset that loss.

Diversification applies what’s called “weatherproofing” principles to your portfolio. Like the weather, the investment market keeps changing. But while the market continues to rise and fall, you can help minimize the effect that market fluctuations will have on your investment portfolio. Think of it as “weatherproofing” your portfolio.

In the first illustration below, sales of Suntan Lotion Inc. and Sunglasses Inc. react similarly on days when the weather is sunny, and are, therefore, positively correlated.

The second illustration below shows that sales of Suntan Lotion Inc. and Umbrellas Inc. behave oppositely on days when the weather is sunny or rainy, and are, therefore, negatively correlated. Investing in negatively correlated companies may result in a diversified portfolio with potentially steadier overall performance.

Diversification is one of the primary reasons why mutual funds are so popular among investors (remember that a mutual fund might comprise as few as 20 stocks or as many as 500 stocks).

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