5 Strategies to Lower Risk

Use the right tools to diversify and you can even out the ups and downs of your portfolio.

The stock-market cataclysm of 2008-09 didn't just wipe out $6 trillion worth of wealth in the U.S. It also destroyed many investors' faith in diversification. That's understandable. The conventional wisdom -- that a portfolio spread among stocks of large and small companies, growth- and value-focused strategies, and domestic and foreign firms would be well equipped to navigate a perilous market -- proved hopelessly misguided. A portfolio spread evenly among those categories would have lost about 57% over the market's full decline, from 2007 through 2009, comparable to the actual 55% drop in Standard & Poor's 500-stock index.

But the failure of such wisdom lies not with diversification itself -- diversification, done properly, does work -- but with the outdated tools the conventional wisdom suggests you use to fashion a well-rounded portfolio. For diversification to improve returns, investors need to spread their money among assets that tend not to swing up or swing down in tandem with one another -- in other words, among assets with low correlations to one another.

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Elizabeth Leary
Contributing Editor, Kiplinger's Personal Finance
Elizabeth Leary (née Ody) first joined Kiplinger in 2006 as a reporter, and has held various positions on staff and as a contributor in the years since. Her writing has also appeared in Barron's, BloombergBusinessweek, The Washington Post and other outlets.