Diversify Your Investment Portfolio Today
If you’re a beginning investor, you’re likely concentrating on building your investment or retirement portfolio. But as important as it is to build that portfolio, you should also ensure that it’s diversified, meaning that you don't put all of your eggs into one basket. Again, scientific evidence backs up the importance of having a diversified portfolio.
Why is a diversified portfolio so important?
There are three key reasons why diversifying is important:
- First, a diversified portfolio helps minimize risk. Stocks can be a risky investment at any time, but with a diversified portfolio, you can help minimize the risk by spreading that risk among various investments.
- Diversifying can help investors maintain capital. For example, someone purchasing stock at the age of 30 has a much different investment goal than someone 50. Therefore, it may be much more important for older investors to maintain capital than increase capital.
- You’ll have a much better chance at generating dividends if your portfolio of stocks is diversified. When one stock is performing well, the chances are that another stock has dipped. By having a significant investment in both, you’ll help offset any potential losses from underperforming stock.
It’s also common for one particular type of asset to perform better over a specific period of time, depending on external factors such as:
- Current interest rates
- Currency markets
- Current market conditions
But it’s also important to remember that while one investment may be outperforming others, the standard is that there is no particular investment that will continually outperform others over the long term.
But what is a diversified portfolio?
A diversified portfolio is where investments vary, with exposure to one particular type of asset is limited. Diversifying can look like two very different things to young investors and those nearing retirement age. Young investors are much more likely to be comfortable riding out the peaks and valleys of their investment portfolio. Investors nearing retirement age are more likely to be interested in slow growth and more consistent performance without the volatility that more risky investments may face.
To truly diversify your investment portfolio, many professionals recommend that your portfolio consists of the following:
- Domestic Stocks. Stocks are perhaps the most volatile investment in a portfolio, but they also represent the best chance for growth. Short-term investment in stocks carries the biggest risk, but stocks can also provide the biggest reward if held on to for a significant amount of time.
- Bonds. Considered less volatile than stocks, bonds can provide a shield against market instability created by stock investments. However, stocks also typically provide regular interest income. High-yield bonds can be purchased for those looking for a more significant return, but they also carry higher risk.
- Money Market Investments. While ultra-conservative, money market accounts and similar investments such as a short-term CD can provide stability and safety, other investment options may not.
- International Stock. International stock can provide a higher return than their U.S. counterparts, but they can also carry a higher risk. However, for those looking to diversify their portfolio, international stock can be a good addition.
Creating a diversified portfolio has become increasingly easy with the now-common use of index mutual funds. One can get a target-based index fund or a balanced mutual fund with a certain percentage of stocks and bonds. Or you can be more ambitious and get 5, or so, index funds consisting of U.S stocks, non-U.S. developed stocks, emerging markets stocks, REITs, and bonds. Of course, we want to have as much international exposure as possible to create greater diversification of your portfolio.
The key to diversification is to find the right balance between risk and stability and add accordingly, which allows you to reach your goals while also worrying less. Always ask your financial advisor to determine your level of risk before proceeding to make investment choices.
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on to avoid any Federal Government tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.