This is a huge question for anyone who invests and it really depends on three things:
1) Time
2) Money
3) Risk Tolerance and Desired Return
For simplicity, we are going to say that there are three investment vehicles:
1) Bonds
2) Mutual Funds
3) Stocks
Bonds are simply loans to the government with the promise to pay the principal(price paid for the bond) plus interest. The best thing about bonds is that they are low risk, but consequently the return is also relatively small.
Mutual funds are another type of investment that collects money from many investors and invests in stocks, bonds, and other securities. The gains or losses from the fund are then passed on to the investors. Mutual funds offer a few advantages: diversification and professional management. While they are more risky then bonds, they offer greater potential returns. They are also a great way to diversify without spending a fortune on commissions to your broker. Stocks are essentially the purchase of a portion of the company you choose to invest in. If the company performs well, you generally reap the benefits(with good management), if it performs poorly, you lose money. Stocks are risky because there is no guaranteed stable flow of money when you buy a piece of the company, but if you do your research and the company does well, the advantage with stocks are the potentially great return on investment.
So, should you diversify? It really depends on your situation. Diversification is a way to limit risk, but it may not be necessary. The first thing to determine is your investment goal(retirement, education, increase net wealth, etc.). Knowing that, you must design an investment strategy based on your goal. If you are saving for retirement, it may be smart to diversify to protect you from risk. If you need a steady, safe flow of money then bonds may be for you. That is not to say you can't buy mutual funds and stocks as well, but it is saying that you should weight the three according to your needs. 50% bonds, 30% funds, and 20% stocks should give you that desired stability, though it is certainly not a concrete figure and should be based on your needs. With investment goals like retirement or education, you may also want to seek a financial advisor to help determine a good allocation of finances. Keep in mind, though, that financial advisors may be biased. For one, they will likely tell you to diversify not only to protect you, but to protect their reputation as well. Also, if the advisor is connected to a brokerage, he is earning a commission for your purchases-be careful that he is not simply padding his or her pockets. It comes down to the fact that no one will watch your money better than you would, but if you need an advisor, hire one who you are comfortable with because ethics is important(especially when they have your money!). There is a great post at Sound Money Tips-"Tip On Questions To Ask A Financial Advisor"-check it out.
If you do not have much money to invest(less than $2000), then mutual funds offer you the opportunity to diversify without stock commissions eating away at your principal. Mutual funds allow you to be a passive investor-you don't have to keep up with news, events, charts- because there is a professional running the fund and doing the dirty work for you.
If your investment goals are high returns and you can tolerate the risk associated with stocks, then the stock market is where you want to invest. Here, if you have the time and money, I really don't think you have to be diversified. Time means research, reading, and learning about the stock market, investment strategies, and the stocks you are interested in. To take the risk associated with the stock market you have to be an active investor-constantly perusing news, quotes, and charts. If you don't have that time, then diversify. Once you put the time in to learn the stock market, you can make informed choices about stocks, and because you're informed, there is less risk than simply taking a flyer on a stock tip. Warren Buffett goes as far as to say, "Diversification is a protection against ignorance. [Diversification] makes very little sense for those who know what they're doing."
The answer to the diversification question is ambiguous-it depends on your situation. Money, time, and goals should shape your investment decisions. The most important thing: don't lie to yourself. If you don't have the time to make informed decisions, hire an advisor to help you invest. If you don't have the money, then go with mutual funds or bonds, or weight your stock exposure so that there is less risk. Finally, set a goal and stick to it-it can be expensive to switch an investment plan along the way.
My name is Joe Martinez and I am a sophomore Economics and English double major at Amherst College in Massachusetts. I have been investing in the stock market for 12 years now-since I was given 3 shares of Disney by my grandparents for my birthday. I play varsity soccer here at college and I recently started an investment blog called "Jomar's Stock Picks" at http://dineromaker.blogspot.com. Business has always interested me and this year I started my first company, Kiely's Paint Specialists, with two of my friends. We started it to help two of our friends who are stationed in Iraq and Afghanistan by pledging 20% of our profits to their respective brigades overseas.