A mutual fund investment involves buying into a wide variety of options that range from individual bonds, stocks and other money market securities. Buy owning shares in a mutual fund investment, rather than individual stocks and bonds, your risk is widely spread out among the portfolios that the investment managers decide to invest in, making your investment even more secure.
This kind of risk spreading is referred to as diversification. Since each option class behaves in a different way, depending on the prevailing market conditions, when one of the securities decline, the losses incurred are balanced by the gains of the other. One arrangement that has always worked for me has been, buying stocks and bonds from the retail sector and offsetting any gains or losses with options in the industrial sector. I make sure i balance the different capitalizations available from the different sectors with the time the bonds will take to mature and vice versa.
Since diversification of mutual funds entails mixing of both retail and industrial sector options, you will reduce the impact in terms of performance of any one portfolio. You will not notice sharp hikes and big falls, what you get will be evenly spread out. Both large and small time investors should always strife to achieve this kind of asset diversification and allocation in order to minimize losses.
It would be important to note that, by itself, a mutual fund investment gives you immediate diversification by the virtue of the fact that many investors have pooled resources together in order to invest in a variety of options, but in itself, it is not enough. You need to invest both in sector and industry based options since, when the industrial segment is doing badly, other sectors of the economy, like insurance and health care would be doing very well. This will cushion you, as an investor, from any hard economic scenario that will definitely be felt when you decide to invest in one security.
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