Believe it or not, portfolio diversification has worked

It looks great on paper. Diversification is the hailed financial theory that says investors can reduce the ups and downs of their portfolio by sprinkling money all over the place in different types of investments, rather than plunking down everything on just household-name U.S. stocks.

Investors who take a closer look, though, can see that diversification has done what it’s supposed to do. And for investors looking for a prudent way to gear up for the stretch goal of saving for retirement, diversification can still be a big key to success.

“Diversification is like a free lunch, or at least a free hors d’oeuvre,” says Ian Ayres, professor of law at Yale University who has studied diversification. “You want to take advantage of it.”

“Diversification is a great tool to protect against risks of problems at a particular company or industry, but not if the entire financial system comes under strain.” Read how diversification can get more powerful over time and what the key ingredients to make your diversified portfolio work at USA Today.

The Right Kind of Diversification

More and more, investors have been hearing that in order to be properly diversified, they need exposure to more asset classes than they previously had assumed. Instead of just stocks, bonds, and cash, many responsible financial writers and advisors–not to mention fund companies trying to pitch their latest wares–now suggest that a portfolio should also include some real estate and perhaps exposure to commodities as well. And of course, as in the past, you’re still told to include among the stocks some smaller companies as well as large, international (and make sure to own emerging markets), and domestic–and both growth and value.

Some investors have responded by owning more and more funds. But the result can be a sprawling, unmanageable portfolio of 20 or 30 funds or more. Others, especially in retirement plans, take the opposite course: They toss up their hands and own just one fund, a target-date vehicle or similar option that provides diversification all on its own.

With more choices, naturally comes greater confusion.  However, the proliferation of funds need not lead to confusion or overstuffed portfolios. This article from Morningstar points out the importance of investing through diversification – To Meet your Goals. Read more on The Right Kind of Diversification.

Update: New link of the article.