How do you diversify your portfolio?
Through ordinary real-life experiences that are unrelated to the stock market, we can learn a few things about diversification. For example, you may have noticed that street vendors often sell seemingly unrelated products e.g. umbrellas and sun hats. At first glance, it may seem odd that someone would buy both items at the same time. Street vendors know that when it’s raining, it’s easier to sell umbrellas but harder to sell sun hats. However, when it’s sunny, the reverse is true. By selling both items - i.e., by diversifying their product line - the vendor can reduce the risk of losing money on any given day. These are the building blocks to understanding asset allocation and diversification.
Asset allocation involves dividing your investment portfolio among different asset class, such as stocks, bonds, and money market instruments. The process of determining which mix of assets to hold in a portfolio at any given time will depend largely on your time horizon and risk tolerance.
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