Why diversifying your portfolio is important

Diversification involves spreading your investments across different asset classes, which can range from stocks, bonds to EFTs and real estate.

When done correctly, diversification can minimize volatility while maximizing return opportunity, Shon Anderson, a Dayton, OH-based CFP and chief wealth strategist at Anderson Financial Strategies, told CNBC Select.

"Each asset class performs differently in various economic and financial environments," Anderson said. "When you have multiple asset classes, you should have more opportunities to have pieces of your portfolio make money in almost any environment."

Greg DePalma, a Denver-based CFP and director of advisory services at Empower, likens diversification to running a fruit stand.

"If a hurricane wipes out the orange groves in Florida, it would be helpful if you also sold apples from the Northeast or bananas from Hawaii," DePalma said. In the same way, managing your portfolio holistically means considering how one asset can offset the other.

Large-cap growth stocks and large-cap value stocks can perform very differently. Growth stocks outperformed value stocks by a huge margin in 2020, while value stocks outperformed growth stocks this year.

Investing in both means any losses in one asset will be offset by the gains in the other.

One of the easiest ways for investors to diversify is by investing in a large number of companies through pooled investments, such as mutual funds and ETFs, or by purchasing a sufficient number of individual securities.

"Investors [should] attempt to diversify away from any risk involved with a specific company or investment," DePalma said.

Whatever route you choose, he added, talk to a financial advisor about your specific risk tolerance and time horizon.

"The goals of different investors are usually not the same," DePalma said. "A young couple with no children, for instance, may want to try to maximize their returns with the understanding that the [investments] may be more volatile, while a retired couple might desire steadier returns to take their family on vacation every few years."

If you don't have a financial planner, Anderson recommends using a robo-advisor or target-date index funds, that update your investments as you approach your goal retirement date.

Many robo-advisors use modern portfolio theory (MPT), which follows funds like the S&P 500 and prioritizes diversification to minimize risk. Robo-advisors rely on low-cost mutual funds or exchange-traded funds (ETFs) that spread your investments across different assets.

Betterment and Wealthfront are among our top picks for robo-advisors.

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