When it comes to investing, the old saying that “a little of something is worth more than a lot of nothing” certainly holds water. In other words, you can’t expect to get rich from putting all your eggs in one basket. That being said, not everyone has the same risk tolerance or personal preferences when it comes to how they manage their money. To that end, diversifying your portfolio should be one of your top considerations before making any new investments. There are many different ways to diversify your portfolio, and the sooner you take action on doing so, the better off you’ll be down the road. In this blog post we will cover some of the basics when it comes to diversifying your portfolio and some strategies that may prove beneficial for you moving forward.
What Does Diversification Mean?
Diversification is the practice of spreading your money across multiple assets, industries and market sectors, which allows you to limit the financial damage that might occur if one or two of your assets fall in value. For example, if you have $100,000 and put it into one stock for an oil company, and that stock has a major fall in value, you’re going to lose a lot of money. But if you spread that $100,000 across 10 different stocks across industries and doing things like getting a loan for a rental property with a lower risk than the one in which you had invested the full amount, then even if one or two of those stocks has a fall in value, you’re still going to come out ahead. In short, diversification is all about managing risk. Risk is a part of every investment, but by spreading your money across different types of assets, you can lower the amount of risk you’re taking on. Depending on your situation, you may even be able to take on more risk and earn higher returns as a result.
Why is Portfolio Diversification Important?
We’ve already established that diversification is the practice of spreading your money across multiple assets, industries, and market sectors. But why is it important? Well, there’s a good chance that at some point in your life you’ll experience a significant financial loss. Whether it’s due to unexpected events, like job loss or health issues, or just a bad investment bet, there’s no way to completely eliminate the risk of financial loss. What you can do, however, is minimize the impact of these losses by diversifying your portfolio. This allows you to protect your long-term financial goals, such as saving for retirement, while also minimizing your short-term financial stresses.
Asset Allocation: How to Diversify Your Portfolio
Before you start purchasing various assets, you’ll want to do some research to determine which types of assets are best for each portion of your portfolio. This is known as asset allocation, and it typically breaks down into three categories: equity, fixed income, and cash equivalents.
- Equity – Equity refers to stocks and other securities that are issued by companies in the hopes of raising money to grow their businesses. Over the long term, equity investments tend to generate higher returns, but they’re also riskier because the value of these investments can fluctuate significantly in response to changes in the economy, industry conditions, and other factors.
- Fixed Income – Fixed income is a type of investment that allows you to earn a relatively modest amount of money with a relatively low level of risk. This includes things like bonds, fixed-rate and variable-rate treasury securities, and other low-volatility securities.
- Cash Equivalents – Cash equivalents are savings and money market accounts that are considered very low risk. This also includes things like short-term government bonds and treasury notes.
Exchange Traded Funds (ETFs)
Exchange traded funds, or ETFs, are a type of investment fund that holds a collection of assets, such as stocks, commodities, and other securities, and splits the total assets between many investors. ETFs are traded on a stock exchange, just like stocks, which means they can be bought and sold throughout the day as opposed to being purchased through a traditional brokerage firm and settled at the end of the trading day. This makes ETFs very attractive to investors who want to make frequent changes to their investments, such as those who are trying to actively manage their risk. Another benefit of ETFs is that they are very low cost, with many ETFs charging as little as 10 basis points per year in fees, which is significantly less than many mutual funds.
Mutual Funds: A Great Way to Diversify
Mutual funds are another great way to diversify your portfolio. Mutual funds are investment companies that pool money from various investors, then use that money to purchase a wide range of stocks or other assets. The fund manager then decides how to invest the money within each fund, aiming to produce a particular level of return for each investor who has contributed to each fund. Mutual funds are a great way to diversify because you can spread your money across multiple funds, each with a different investment strategy, helping to minimize your risk. You can also select from a wide range of mutual funds, including those that are tailored to meet the specific investment needs of young investors, such as those saving for retirement or those already retired.
Robo-Advisors: The Millennial Investors’ Best Friend
Robo-advisors are online financial services that offer portfolio management and other investment advice with little to no human intervention. This is great news for millennial investors who aren’t interested in managing their money manually, or who may not have the financial know-how to do so. Robo-advisors use sophisticated algorithms to select investments, diversify your portfolio, and rebalance your portfolio as needed to maintain your desired risk level. The best robo-advisors will also provide you with ongoing educational content and advice, allowing you to focus on your day-to-day activities while they maintain your investments for the long term.
Well-managed portfolios need not be overly complex. The SEC provides investors with a checklist for how to build a diversified investment portfolio. The following are the basic components of a well-diversified portfolio:
(Disclaimer: This content is a partnered post. This material is provided as news and general information. It should not be construed as an endorsement of any investment service. The opinions expressed are the personal views and experience of the author, and no recommendation is made.)
