Mixing it up: Diversification and asset allocation

Ask anyone on the street what diversification is when it comes to investing. “That’s not putting all your eggs in one basket, right?” is what you’ll probably hear. Ask that same person what asset allocation is and you might get a blank stare—unless you’re standing somewhere on Wall Street.

Diversification and asset allocation — what’s the difference?

The truth is, diversification and asset allocation are very similar concepts. Diversification is indeed not putting all your investing eggs in one basket, but instead spreading your investment risk among different investments so you’re not exposed to the risk of a single investment or even a few. The general rule of diversification is that while some of your investment choices may falter, others may perform well (although neither asset allocation nor diversification ensures a profit or guarantees against loss).

Asset allocation takes this concept a step further. When you practice asset allocation, you want to allocate—or divide—your investments among the three main asset classes:

• Equities – Commonly referred to as stocks, equities give you a greater potential for growth, but they also come with a higher investment risk. Generally, the more years until retirement—and the longer you have to ride out short-term changes in the market—the bigger the role equities or stocks could play in your investment mix. Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risks, including the loss of principal.
• Bonds – Also known as fixed-income investments, bonds are generally less risky than equities, so they can help offset some of the investment risk equities can create. The potential risk and return on bonds is moderate—generally lower than equities, but higher than short-term investments. In general, bond prices rise when interest rates fall, and vice versa. This effect is usually more pronounced for longer-term securities.
• Short-term investments – Also referred to as money market or cash investments, short-term investments are considered the least risky of the three basic investment types. But they also tend to produce the lowest returns over the long run. Short-term investments often become more important as you get closer to and into retirement.

What does this mean? Let’s say, for example you have a diversified portfolio of energy stocks—or even a well-diversified portfolio of stocks in different industries. Without additional investments in different investment types, you’re not diversified across asset classes. You’re practicing diversification but not asset allocation.

The proportion of your assets you allocate to each asset class—equities, bonds, and short-term investments—should depend on your tolerance for risk and change over time. If you’re getting close to retirement, you may want to weigh your portfolio toward more conservative investments than you did when you were younger. You should also consider your attitude about risk as well as your personal financial situation.

Diversification and asset allocation are both important

Diversified portfolios with appropriate asset allocations tend to provide less volatile returns over the long-term and can help minimize downside risk. That said, it’s also important to diversify within each asset class.

For instance, factors such as inflation and market interest rates can affect whole asset classes like bonds and stocks differently—making asset allocation a wise way to diversify. Then, if you diversify within each asset class—for example, by choosing equity funds with investments in different industries—you’ve reduced your risk of being affected by factors that can impact the performance of individual stocks or industries. It’s a great way to invest for the long haul and reduce your own anxiety about volatile markets.

Need help choosing investment options or learning more about investing? Call the Hewlett Packard Enterprise Benefits Service Center at Fidelity at 1-800-409-4015 from 7:30 a.m. to 11:00 p.m. CT. 

Keep in mind, investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.

Investing in bonds involves risk, including interest rate risk, inflation risk, credit and default risk, call risk, and liquidity risk.

An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.

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