Historical returns have shown that a carefully chosen investment plan can be a powerful way to overcome the effects of inflation. Diversification and the strategy of asset allocation play an important part in this plan. Diversification Diversification is the process of accumulating securities in different types of investments, industries, risk categories and companies in an effort to reduce the potential risk of loss from any one investment. If all of your money is invested in one place, you are totally dependent on the strength of that single investment. No matter how sound that investment may be, there are times when it will be affected by price fluctuation or inflation.
Diversification helps to alleviate the effects of a down cycle of any one investment.
Asset Allocation Diversification is carried out a step further through asset allocation. Rather than placing all of your money in one type of investment, the concept of asset allocation dictates that you distribute your investments between these asset classes. Historically, different asset classes have reacted differently to changes in the economy. So by allocating your portfolio into multiple asset classes, you may actually reduce risk and improve returns. Of course there are no guarantees, but research shows that asset allocation is one of the most significant contributors to portfolio performance.