Aug 4, 2022
-Investing is key to building wealth, but knowing where to start and what to invest in can be tricky.
-Diversification means you invest money in different types of investments instead of investing all of your money in just one or two assets.
-When you diversify in different types of investments, you reduce the risk of losing money or getting negative returns.
Remember the old saying, “Don’t put all your eggs in one basket”? Ever wondered why everyone says that? We’ll tell you in one word. Diversification!
Diversification is like putting your eggs in many different baskets to keep them safe. Think of your money as your eggs. Would you rather put all of them in one basket or spread them across multiple baskets?
If you opted for the prior, how would you feel if that one basket with all of your eggs (or your money) got lost? What if you had your money spread among 100 baskets? Phew! One missing basket out of 100 wouldn’t be as big of a loss.
So, what do eggs have to do with investments? Well, smart investors use this same thought process to diversify their tangible assets (physical items of value) and their intangible assets (non-physical items of value). They spread their money across multiple types of assets to reduce the risk of losing money — building a diversified portfolio.
Imagine you invested all of your money in individual stocks of GAMER (GMR). GAMER is a (made-up) gaming company, so this would mean that 100% of your equity (or stocks) is in the gaming sector of the market. This is a rather risky approach because if GAMER stock prices were to go down suddenly, your whole investment portfolio may see losses.
You might diversify within the gaming sector by investing in other gaming companies, but if the whole gaming sector is negatively impacted, your portfolio may still take a big hit in the short term.
To truly diversify a portfolio, include stocks from different companies and industries. You may also want to consider adding bonds or other fixed assets (items of value for long-term use) to the mix. Three of the most common asset types you’ll hear about are stocks, bonds and cash (or assets that can be converted to cash).
Many investors will blend several of these types of assets together, so their portfolio isn’t focused on one individual asset class or market sector. By doing this, your money is better protected against a dip in the stock market as a whole.
By choosing not to put all of your eggs in one basket, you are protecting your money from market uncertainty. But remember, diversification may look a little different for each investor. Different factors like time and risk tolerance will ultimately determine what the right portfolio looks like for each person. Luckily, there are plenty of tools available to help diversify your investment accounts through smart asset allocation.
Diversification reduces your overall risk while increasing the potential for higher returns, especially when planning for long-term goals. That’s because sometimes some of our investments will perform well while others won’t.
Though we can’t predict which ones are winners, diversification ensures your portfolio isn’t ever missing out. In fact, a well-diversified stock portfolio may typically earn the market’s average long-term historical return. That’s roughly 10.5%, on average!
Investing isn’t just for the rich. Anyone, including kids and teens, can learn to invest and start building wealth. Not sure where to start? That’s where we come in. At Greenlight, we’re empowering the next generation of investors. We provide all the tools and information necessary to get started.
But, before you pool money and jump into investing, let’s understand how the most common asset classes — stocks, bonds and cash — work.
Stocks (sometimes referred to as shares) allow investors to own a piece of a company. People who own shares of a company’s stock can proudly call themselves owners of that company, or “shareholders”. The price of a stock can fluctuate based on how well a company is doing financially or how well investors perceive it will perform in the future.
As a partial owner of the company, a stockholder may also receive some of the company’s profits in the form of dividends. Other companies may not offer dividends, preferring to provide high returns to investors when they sell, though these “growth stocks” also tend to be much more volatile.
Buying bonds (or fixed-income assets) essentially means you are loaning money to either a company or a government. And in time, the company or government will pay back the loan with interest. Bonds can be short-term or long-term, and the length of the bond can change the amount of interest paid.
Bond owners can also sell their bonds to someone else at a higher or lower price than what they bought them for. This exchange can cause bond prices to change. However, bonds generally have a lower return compared to stocks.
Cash (or cash equivalents) include any money in a certificate of deposit (CD) or money market account.
Lastly, there are other asset types like real estate, commodities and alternative investments (like crypto). These asset classes are different from the stock market and can be another way to diversify your portfolio. While some assets are backed by actual property (like real estate), other assets, like crypto, can’t be seen as they’re 100% virtual. Does that mean they’re riskier? Let’s find out.
Now that we’ve talked about why diversification matters, it’s important to reiterate that there will always be risks when investing your money. Though it’s pretty unlikely, risk means you could potentially lose some — or even all — of the money you invest.
While bonds from the U.S. government are considered some of the safest investments, other assets like cryptocurrency can be very volatile. Just take a look at the price of Bitcoin, month over month. For example, on May 16, 2022, Bitcoin’s price was nearly $30,000. Fast forward to June 16, 2022, Bitcoin’s price is at nearly $21,000.
Woah! By doing your research, you’ll quickly realize that its price isn’t anywhere near steady or stable. This means you’re assuming more risk by investing, with the potential for more reward.
Want steadier returns and lower risk? Index funds can help with that. Index funds track the return of a market index, like the S&P 500. So instead of investing in one stock, index funds let you invest in a variety of stocks with just one purchase. Want to learn more? You can read all ETFs and mutual funds here.
With so many investment options, you can get all the benefits of diversification! Ready to open an investment account? Greenlight lets you open a brokerage account and invest without any of the transaction fees.
Now that you know what investment options are available to you — try putting your knowledge to the test. As a parent, you can use Greenlight's Investing for Parents to save money for your kid’s future. Get a recommended fund with Greenlight’s personalized quiz and take out your investments whenever you’d like.
And for kids and teens, Greenlight's Investing for Kids lets them use their app to research, explore and learn about the world of investing. Kids can request for parents to buy or sell stocks or index funds and parents can place each trade with just one tap.
Remember, at Greenlight, we want investing to be as accessible as possible. You and your kids can choose how much to invest together. And with fractional shares, your family can start investing with as little as $1.
The best part? Find more than 4,000 stocks and ETFs to research in the app — and explore the world of investing, together. Sign up today! Get one month, on us.
After your one month trial, plans start at just $4.99/month for the whole family. Includes up to five kids.