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Investing Specialists

The Error-Proof Portfolio: Take Diversification to the Next Level

Hedge your bets to allow for an array of outcomes.

Diversification has been called "the only free lunch in finance." A lot of hard data illustrate the benefits of building a portfolio that's diversified across asset classes and investment styles, and dividing your eggs across multiple baskets has commonsense appeal, too. If you don't know whether stocks will continue their current run or take a breather, if small caps will outperform large, or if interest rates will go up or down--and no one truly knows those things--diversifying is a sensible way to hedge your bets. It also helps ensure that your portfolio will perform reasonably well in a variety of market environments.

Yet as widely accepted as diversification is at the portfolio construction level, investors could benefit by construing it even more broadly. In general, diversifying makes sense any time you're uncertain about an outcome (and that's pretty much all the time, as I argued in this article).