The Ultimate Investment Diversification Quiz

Investing is like a game of roulette, because you can increase your odds of winning by betting on more than one number, but each number you add reduces your potential payout. If you want to hedge your bets, then spread your investments over several options.

Spreading your money amongst several different investment vehicles is called investment diversification. Investing in bonds in addition to stocks is a basic example of Investment diversification.

Investment diversification is a safe way to grow your investment dollar. Diversified holdings allow good performers to counterbalance investments that do not perform well during the same period.

Diversification works because by nature it is a long-term position on investing. Short-term market performance is almost impossible to predict and mixed investments perform best in the long-term.

With investment diversification, you should not worry if some assets perform poorly in any give year. The rule here is that, spread over time, winners will consistently outnumber losers.

The three distinct investment classes are stocks, bonds and cash. The purpose behind investment diversification is to balance your investment risk among the three classes.

You have to be willing to take some risk with your investments if you expect growth and return on investment. If you are not willing to take a risk you will not likely make any money investing.

Stocks are generally considered to be the riskiest investment option among the three classes. Stocks are divided into small cap, mid cap and large cap based on the size of the company.

According to Investopdia, market capitalization refers to the total dollar value of a company’s outstanding shares. Market capitalization is calculated by multiplying the current market value of each stock by the total number of a company’s shares in circulation.

According to information provided by Wells Fargo, a small cap company is one with less than $1 billion of market capitalization. According to IMS Capital Management Inc., mid cap companies tend to carry less risk than the other two classes.

According to Wells Fargo, a large cap company is one with more than $5 billion of market capitalization. High cap companies tend to carry the greatest risk of the three stock classes.

Along with lower risk comes lower return on investment potential. The only exception is junk bonds that offer a higher return on investment, but they have a low credit rating and are more likely to default.

Cash investment accounts are a safe place to put some of your money where it is at little risk of loss. One shortcoming of cash accounts is that often they have a fixed term and you suffer a penalty if you must move money early.

Allocation of investments refers to the process of allocating amounts of money to invest in each asset class. Allocation is dependant upon the relative amount of risk you are willing to take with your assets.

A major consideration when you are allocating investment funds is your stage in life. Generally the younger you are, the more risk you can take with your assets, because you have many years to gain from a long-term investment strategy.

Some investments experts recommend that you become a more conservative investor as you approach retirement age. A comfortable allotment could be around 60 percent in stocks and 40 percent in bonds.

It is not enough to diversify your investments across investment classes, as it creates unnecessary risks. You must also diversify within each class.

You want to adopt a strategy of spreading your money into as many differing sectors of the economy as possible. A simple example of this concept is: If you invest in a steel producer you should also invest in a company that does not use steel.

According to Wells Fargo, a good tool to use when you are trying to diversify your assets is a style chart. You can create a style chart on your computer using Excel or you can even draw one with pencil and paper.

According to The Wall Street Journal, rebalancing your portfolio might seem illogical. When you rebalance your portfolio, you are essentially selling assets that are performing well so you can purchase more assets that are doing poorly and this seems to defy logic.