A diverse world is a safe(r) world

And by "world" I, of course, mean your stock portfolio.

So far, in each blogpost, I've explained the basics of what you need to know to buy the stock of an individual company. Although you do need to know this, a more important [and very familiar] principle stands:

Avoid putting all your eggs in one basket.

This principle is known as diversification. Basically, it involves owning a number of stocks of companies in different industries, geographies, etc etc. You might hear the rule that a properly diversified investment portfolio contains 30 to 40 stocks, which you can gather yourself OR you can let someone else do it for you, with a mutual fund or an exchange-traded fund.

A mutual fund is a diverse portfolio of stocks (or bonds) that is managed by an asset management firm. The "mutual" part comes from the fact that it is funded by a ton of different people. Money is pooled from many different investors and the asset manager invests on their behalf.

If your job offers you a 401k or 403b plan, you have likely bought a mutual fund. It is one of the easiest, best ways to get a diversified portfolio, since these funds can include hundreds, or even thousands, of stocks.

Another way to get diversity is through an exchange-traded fund, more widely known as an ETF. ETFs work essentially the same way as a mutual fund, but is traded on an exchange, such as the New York Stock Exchange. Mutual funds are not publicly traded, so an ETF can be more convenient for those who do not have access to a 401k plan.

Both mutual funds and ETFs give you about a million investing options. Some funds invest companies in one industry specifically; some invest based on geographies. Some reflect popular indices such as the Dow Jones Industrial Average or the S&P 500, called index funds.

Conservative Wall Street veterans will likely recommend that you go with an index fund, particularly one that includes more companies rather than fewer. While the Dow's price is frequently quoted, the index is made up of only 30 stocks, the largest companies in the US. Bigger isn't always better: these companies don't necessarily reflect what's going on in the whole market. The S&P 500, which contains 500 companies' stocks, is a better bet, and the Wilshire 5000, even better.

So next time you're tinkering with your job's 401k, don't be shy. See what index funds are available. Next time, I'll teach out how to seek out the best for you.