Diversification is one of the most important safeguards in investing. The idea is simple. By building your portfolio using different types of assets (stocks, bonds and short-term reserves, for example), you spread out your risk. In a diversified portfolio, when one type of investment does poorly, another type may prosper. Your winners can help offset your losers, and the value of your overall portfolio may not fluctuate as much. Keep in mind that diversification does not ensure a profit or protect against a loss.

Your investments will fall into one or more of three asset classes, each with its own level of risk and reward:

• Stocks represent partial ownership of a corporation. A stock can increase in value through a rise in the market price of its shares. Many stocks also pay dividends.

  Key risk: Stock prices move unpredictably depending on the company’s performance, market swings and the economy. Stocks have yielded the highest returns over the long term but can also experience prolonged downturns. Keep in mind, though, past performance is no guarantee of future results.

  Some typical ways to divide stock funds are by investment style and country or region, such as:
  

  • Growth stocks. Stock of companies believed to have stronger-than-average prospects for rapid growth in sales and profits.
  • Value stocks. Stocks of companies that often pay relatively high dividends and may be priced low enough to make them attractive investments.
  • International stock funds. Stocks of non-U.S. companies.

• Bonds are longer-term loans made to a company, government or government agency. The borrower, or issuer, agrees to repay the principal after a certain period and also to make regular interest payments along the way.

  Key risk: When interest rates increase, bond prices usually fall. (Conversely, when rates fall, bond prices generally rise.) An example is a municipal bond your state might issue to pay for a bridge.

  One way to categorize a bond fund is according to the average maturity of the fund’s holdings:
  

  • Short-term. Average maturity of one to five years.
  • Intermediate-term. Average maturity of five to ten years.
  • Long-term. Average maturity of more than ten years.

• Short-term reserves are usually short-term loans to creditworthy borrowers. They are designed to preserve the principal value of your investment and provide income that rises and falls with short-term interest rates. Examples are U.S. Treasury bills, certificates of deposit (CDs) and money market instruments.

  Key risk: Because short-term reserves are conservative investments, they usually generate the lowest returns and are vulnerable to the effects of inflation.

Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.

All investing is subject to risk, including the possible loss of the money you invest.