The strategy behind diversification is by investing in various types of investments (stocks, bonds, real estate, precious metals, etc.) and bydiversifying within each type of investment (by investing in several different industries, for example), you will not be as seriously affected if a particular type of asset (or a particular company or industry) suffers. How can youdiversify your portfolio? Let’s go back to the basics, the ABCs of investment diversification.

Analyze Your Needs.

You must first ask yourself why you’re investing. Are you investing forgrowth, to save money for your children’s educations, for example? Or, are you investing for income, to help you through your retirement years? Perhaps, you’re in between those stages – your children are in college but you’re also saving for retirement. In that case, you might look for somecombination of both growth and income.

Balance Your Needs with Your Resources.

Because most financial planners suggest that you hold some investments you can convert to ready cash if an emergency arises, you first need to decide what percentage of your portfolio will be in cash or cash equivalents (Treasury bills, for example). Many people choose a 10 percent to 15 percentrange. Then you need to invest the remaining 85% to 90% according to yourneeds and your tolerance for risk.

If you’re investing for growth, you may wish to allocate your assets among growth investments such as growth stocks, real estate, etc. An incomeinvestor might look to bonds, certificates of deposit, high-dividend stocks, and the like. If you’re seeking both income and growth, you may want toallocate your portfolio between income- and growth-type investments. Thepercentages you choose to place in each type of investment will depend on your unique needs and objectives.

Choose Your Investments.

Once you’ve decided upon your percentages, you can then choose the specific investments within each type. Thus, if you decide you want 30 percent ofthat money to produce tax-free income, you might evaluate the municipal bonds available. Then, you could select those that pay the highest rate ofreturn or, perhaps, those that offer the best tax advantages (your home state’s bonds, for instance).

Finally, make sure you monitor your investments regularly. As yourcircumstances change, so will your needs, and, hence, your investment objectives. Most people seek growth when they’re younger, and income asthey get older. If you expect to follow that pattern, you must decide when tomake that switch and whether to do it gradually or all at once.

ALAN S. MOORE, a financial advisor with Legg Mason Wood Walker, Inc., adiversified securities brokerage and financial services firm, writes this column every Wednesday for L’Observateur.

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