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A diversified portfolio means spreading your investment around into several different areas to minimize your risk of losing your money. Here are some tips and formulas for balancing gains against loss.

What is a diversified portfolio?

A diversified portfolio means not investing in a single type of investment only, such as stocks, but rather investing percentages of your money into different areas such as stocks, bonds, CDs, precious metals, real estate, high-yield savings, and potentially more.

The “farmer’s rule” applies to investing

Farmers are generally practical people. And one of their most famous sayings is: “Don’t put all your eggs in one basket.”

This was born of the idea that if a farmer went to the henhouse to collect the morning eggs, and had put them all in a single basket, then tripped and fell or the basket broke, they would lose all of the day’s eggs and have none at all. Better to make several trips with a smaller number of eggs at a time.

This same logic applies to investing: Don’t bet all your money on a single investment. Spread it around.

Some investments offer a high return, but they also come with an equally high level of risk. Some investments offer a lower return, but the risk is equally low for losing your money. Sometimes it’s better to have a small return than 100% of nothing.

Investing and gambling logic

Another way to think about a diversified portfolio is to compare it to gambling.

Luckily, investing isn’t quite as risky as straight-up gambling on the whole, although there are certainly high-risk investments to be made. 

Gamblers, as a rule, don’t go to Las Vegas and take all the money they have and put it all on a single bet. Instead, they bet a little at a time and often on a variety of games.

Investing uses the same “bet a little bit here and there” logic, unlike Las Vegas-style gambling, with much greater odds in favor of the investor.

Two formulas for diversifying a portfolio

Many factors will determine the best formula each individual should apply to diversifying their portfolio, but here are a few things to consider:

· Current age and number of working years left

· How much money you have left for investments after paying expenses

· What age you want to retire at

· How much money you will need at retirement to support your lifestyle

Formula #1: Younger workers: 60/40 rule

As a general rule, younger workers with a significant number of working years left should consider a portfolio mixture of 60/40, with 60% invested in stocks (high-risk investments), with the remaining 40% allocated to safer, fixed-income investments such as bonds, the experts at the Motley Fool, advise.

Formula #2: Older, closer to retirement: 110 rule

However, older workers with few working years left should have the majority of their portfolio leaning toward safer investments.

Subtract your age from 110 and invest the remaining number as the percentage of your portfolio into equities (stocks) while putting the rest of your investment money into other, safer investments such as bonds.

Example: Let’s say you are 62 years old.

110 – 62 = 48.

Invest 48% of your portfolio in stocks, and the other 52 percent in bonds, CDs, and high-yield savings accounts (you should leave some available cash for a few years of living expenses and/or if the market crashes).