4/29/2020 Guide to diversification | Fidelity

The guide to diversification

Build a solid investment strategy to help realize your goals—no
matter what the market does.
FIDELITY VIEWPOINTS – 03/17/2020 - 7 MIN READ

96% who voted found this helpful

Key takeaways
Diversification can help manage risk.
You may avoid costly mistakes by adopting a risk level you can live with.
Rebalancing is a key to maintaining risk levels over time.

It's easy to find people with investing ideas—talking heads on TV, or a "tip" from
your neighbor. But these ideas aren't a replacement for a real investment strategy
that can help you achieve your goals no matter what surprises the market serves up.

We believe that you should have a diversified mix of stocks, bonds, and other
investments, and should diversify your portfolio within those different types of
investment. Setting and maintaining your strategic asset allocation are among the
most important ingredients in your long-term investment success.

Then give your portfolio a regular checkup. At the very least, you should check your
asset allocation once a year or any time your financial circumstances change
significantly—for instance, if you lose your job or get a big bonus. Your checkup is a

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good time to determine if you need to rebalance your asset mix or reconsider some
of your specific investments.

Why diversify?
The goal of diversification is not necessarily to boost performance—it won't ensure
gains or guarantee against losses. Diversification does, however, have the potential
to improve returns for whatever level of risk you choose to target.

To build a diversified portfolio, you should look for investments—stocks, bonds,

cash, or others—whose returns haven't historically moved in the same direction and
to the same degree. This way, even if a portion of your portfolio is declining, the
rest of your portfolio is more likely to be growing, or at least not declining as much.

Another important aspect of building a well-diversified portfolio is trying to stay

diversified within each type of investment.

Within your individual stock holdings, beware of overconcentration in a single

investment. For example, you may not want one stock to make up more than 5% of
your stock portfolio. Fidelity also believes it’s smart to diversify across stocks by
market capitalization (small, mid, and large caps), sectors, and geography. Again,
not all caps, sectors, and regions have prospered at the same time, or to the same
degree, so you may be able to reduce portfolio risk by spreading your assets across
different parts of the stock market. You may want to consider a mix of styles too,
such as growth and value.

When it comes to your bond investments, consider varying maturities, credit

qualities, and durations, which measure sensitivity to interest-rate changes.

Diversification has proven its long-term value

During the 2008–2009 bear market, many different types of investments lost value
at the same time, but diversification still helped contain overall portfolio losses.

Consider the performance of 3 hypothetical portfolios: a diversified portfolio of

70% stocks, 25% bonds, and 5% short-term investments; an all-stock portfolio; and
an all-cash portfolio. As you can see in the table below,1 a diversified portfolio lost
less than an all-stock portfolio in the downturn, and while it trailed in the
subsequent recovery, it easily outpaced cash and captured much of the market's
gains. A diversified approach helped to manage risk, while maintaining exposure to
market growth.

Diversification helped limit losses and capture gains through the financial crisis
and recovery

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Source: Strategic Advisers, Inc. Hypothetical value of assets held in untaxed accounts of $100,000 in an
all-cash portfolio; a diversified growth portfolio of 49% US stocks, 21% international stocks, 25%
bonds, and 5% short-term investments; and all-stock portfolio of 70% US stocks and 30% international
stocks. This chart’s hypothetical illustration uses historical monthly performance from January 2008
through February 2014 from Morningstar/Ibbotson Associates; stocks are represented by the S&P 500
and MSCI EAFE Indexes, bonds are represented by the Barclays US Intermediate Government
Treasury Bond Index, and short-term investments are represented by US 30-day T-bills. Chart is for
illustrative purposes only and is not indicative of any investment. Past performance is no guarantee of
future results.

Why is it so important to have a risk level you can live with? The value of a
diversified portfolio usually manifests itself over time. Unfortunately, many investors
struggle to fully realize the benefits of their investment strategy because in buoyant
markets, people tend to chase performance and purchase higher-risk investments;
and in a market downturn, they tend to flock to lower-risk investment options;
behaviors which can lead to missed opportunities. The degree of
underperformance by individual investors has often been the worst during bear
markets.

"Being disciplined as an investor isn't always easy, but over time it has
demonstrated the ability to generate wealth, while market timing has proven to be
a costly exercise for many investors," observes Ann Dowd, CFP®, vice president at
Fidelity Investments. "Having a plan that includes appropriate asset allocation and
regular rebalancing can help investors overcome this challenge."

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Building a diversified portfolio

To start, you need to make sure your asset mix (e.g., stocks, bonds, and short-term
investments) is aligned to your investment time frame, financial needs, and comfort
with volatility. The sample asset mixes below combine various amounts of stock,
bond, and short-term investments to illustrate different levels of risk and return
potential.

Choose the amount of risk you are comfortable with

Data source: Morningstar Inc., 2019 (1926–2018). Past performance is no guarantee of future results.
Returns include the reinvestment of dividends and other earnings. This chart is for illustrative purposes
only and does not represent actual or implied performance of any investment option. See footnote 2
below for detailed information.

The purpose of the target asset mixes is to show how target asset mixes may be created with different
risk and return characteristics to help meet a participant's goals. You should choose your own
investments based on your particular objectives and situation. Remember, you may change how your
account is invested. Be sure to review your decisions periodically to make sure they are still consistent
with your goals.

Diversification is not a one-time task

Once you have a target mix, you need to keep it on track with periodic checkups
and rebalancing. If you don't rebalance, a good run in stocks could leave your
portfolio with a risk level that is inconsistent with your goal and strategy.

What if you don't rebalance? The hypothetical portfolio shows what would have
happened if you didn’t rebalance a portfolio from 2006–2019: The stock allocation
would have grown dramatically (see chart).

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How an investment mix can change over time

This chart's hypothetical illustration uses historical monthly performance from January 1997 through
December 2018 from Morningstar/Ibbotson Associates; stocks are represented by the S&P 500 and
MSCI EAFE Indexes, bonds are represented by Barclays US Intermediate Government Treasury Bond
Index, and short-term investments are represented by US 30-day T-bills. Chart is for illustrative
purposes only and is not indicative of any investment. Past performance is no guarantee of future
results.

The resulting increased weight in stocks meant the portfolio had more potential risk
at the end of 2019. Why? Because while past performance does not guarantee
future results, stocks have historically had larger price swings than bonds or cash.
This means that when a portfolio skews toward stocks, it has the potential for bigger
ups and downs.2

Rebalancing is not just a volatility-reducing exercise. The goal is to reset your asset
mix to bring it back to an appropriate risk level for you. Sometimes that means
reducing risk by increasing the portion of a portfolio in more conservative options,
but other times it means adding more risk to get back to your target mix.

A 3-step approach
Investing is an ongoing process that requires regular attention and adjustment.
Here are 3 steps you can take to keep your investments working for you:

1. Create a tailored investment plan

If you haven't already done so, define your goals and time frame, and take stock of
your capacity and tolerance for risk.

2. Invest at an appropriate level of risk

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Choose a mix of stocks, bonds, and short-term investments that you consider
appropriate for your investing goals. (Fidelity's Planning & Guidance Center can
help.)

Stocks have historically had higher potential for growth, but more volatility. So if
you have time to ride out the ups and downs of the market, you may want to
consider investing a larger proportion of your portfolio in equities.

On the other hand, if you'll need the money in just a few years—or if the prospect
of losing money makes you too nervous—consider a higher allocation to generally
less volatile investments such as bonds and short-term investments. By doing this,
of course, you'd be trading the potential of higher returns for the potential of lower
volatility.

Once you have chosen an asset mix, research and select appropriate investments.

3. Manage your plan

We suggest you—on your own or in partnership with your financial advisor—do
regular maintenance for your portfolio. That means:

Monitor – Evaluate your investments periodically for changes in strategy, relative

performance, and risk.
Rebalance – Revisit your investment mix to maintain the risk level you are
comfortable with and correct drift that may happen as a result of market performance.
There are many different ways to rebalance; for example, you may want to consider
rebalancing if any part of your asset mix moves away from your target by more than
10 percentage points.
Refresh – At least once a year, or whenever your financial circumstances or goals
change, revisit your plan to make sure it still makes sense.

The bottom line

Achieving your long-term goals requires balancing risk and reward. Choosing the
right mix of investments and then periodically rebalancing and monitoring your
choices can make a big difference in your outcome.

Next steps to consider

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Let's work together

We can help you create a plan for any kind of market.

Analyze your portfolio

Find investing ideas to match your goals.

Stay on track

Watch a video on how to monitor your investments.

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1. Source: Strategic Advisers. Portfolio risk is measured using standard deviation, which is a statistical measure of how much
a return varies over an extended period of time. The more variable the returns, the larger the standard deviation. Investors
may examine historical standard deviation in conjunction with historical returns to decide whether an investment's volatility
would have been acceptable given the returns it would have produced. A higher standard deviation indicates a wider
dispersion of past returns and thus greater historical volatility. Standard deviation does not indicate how an investment
actually performed, but it does indicate the volatility of its returns over time. Standard deviation is annualized. The returns
used for this calculation are not load adjusted.

2. Historical returns for the various asset classes are based on performance numbers provided by Ibbotson Associates in the
Stocks, Bonds, and Inflation (SBBI) 2001 Yearbook (annual update work by Roger G. Ibbotson and Rex A. Sinquefield).
Domestic stocks are represented by the S&P 500® Index, bonds are represented by US intermediate-term government
bonds, and short-term assets are based on the 30-day US Treasury bill. Foreign equities are represented by the Morgan
Stanley Capital International Europe, Australasia, Far East Index for the period from 1970 to the last calendar year. Foreign
equities prior to 1970 are represented by the S&P 500® Index.

This information is intended to be educational and is not tailored to the investment needs of any specific investor.

Past performance is no guarantee of future results.

Diversification and asset allocation do not ensure a profit or guarantee against loss.

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.

Foreign markets can be more volatile than U.S. markets due to increased risks of adverse issuer, political, market, or
economic developments, all of which are magnified in emerging markets. These risks are particularly significant for
investments that focus on a single country or region.

In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices
usually fall, and vice versa. This effect is usually more pronounced for longer-term securities). Fixed income securities also
carry inflation risk, liquidity risk, call risk and credit and default risks for both issuers and counterparties. Lower-quality fixed
income securities involve greater risk of default or price changes due to potential changes in the credit quality of the issuer.
Foreign investments involve greater risks than U.S. investments, and can decline significantly in response to adverse issuer,
political, regulatory, market, and economic risks. Any fixed-income security sold or redeemed prior to maturity may be
subject to loss.

Indexes are unmanaged. It is not possible to invest directly in an index.

The S&P 500 Index is a market capitalization–weighted index of 500 common stocks chosen for market size, liquidity, and
industry group representation to represent US equity performance.

The MSCI® EAFE® (Europe, Australasia, Far East) Index is a market capitalization–weighted index that is designed to
measure the investable equity market performance for global investors in developed markets, excluding the US and
Canada.

The Barclays US Intermediate Government Bond Index is a market value–weighted index of US government fixed-rate debt
issues with maturities between one and 10 years.

Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be
considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact
investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no
warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of,
or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific
situation.

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Equity performance is represented by the Standard & Poor's 500 Composite Index, an unmanaged index of 500 common
stocks generally representative of the US stock market. S&P 500® and S&P are registered service marks of The McGraw-Hill
Companies, Inc., and are licensed for use by Fidelity Distributors Corporation and its affiliates. Fixed income performance is
represented by the Barclays Capital Aggregate Index. The Barclays Capital Aggregate Index is an unmanaged market value–
weighted index representing securities that are SEC registered, taxable, and dollar denominated. This index covers the US
investment-grade fixed-rate bond market, with index components for a combination of the Barclays Capital government and
corporate securities, mortgage-backed pass-through securities, and asset-backed securities. Past performance is no
guarantee of future results. Performance of an index is not illustrative of any particular investment. It is not possible to invest
directly in an index.

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