Diversification

Asset allocation is the first step in achieving broad diversification. While your asset allocation strategy provides percentage allocations to the major asset classes, such as stocks, bonds and cash equivalents, diversification complements your asset allocation strategy by further spreading your investments within each major asset class.

For example, in the stock portion of your portfolio, you may want to diversify among different market segments (domestic and foreign), styles (growth and value), capitalization ranges (small, mid-size and large), and sectors (technology, energy, health care, etc.). Similarly, within the bond component, you may want to diversify among government and corporate bonds, long- and short-term maturities, and high-quality and high-yield securities.

Diversifying within the context of your asset allocation strategy gives you the return potential of a wide variety of securities—investments that may respond differently to changing market and economic conditions. At the same time, diversification may temper your risk exposure, because a loss in one security may be offset by a gain in another. (see chart)

Investment considerations: The use of asset allocation, diversification and rebalancing does not guarantee a profit nor protect against a loss.