Diversification; one of the fancy terms commonly used by investors. When it comes to investing, the most important thing is to diversify. This simply means spreading your money across a variety of securities, so you’re not exposed to one risk. Diversification is something that everyone should do if they want to protect their portfolio from being destroyed by a bear market and it can also help you earn better returns over time.
Diversifying eliminates the high risks involved in any single investment stream. As you add more securities you add to your portfolio, you reduce specific company or industries risk and eventually you’re only exposed to systematic risks which are inherent in the entire stock market.
There are many ways to diversify your investments but here are some ideas:
Stocks are a core part of any diversified portfolio
Stocks are a core part of any diversified portfolio. The most common way to diversify is through stocks, which can be broken down into industry sectors and market capitalization (the total value of all outstanding shares), as well as price-to-earnings ratios. You can further diversify your stock investments by acquiring stocks of companies operating in different sectors of the economy, and different economic regions in the world.
Bonds can be diversifying and provide income to a portfolio
Bonds are a type of debt instrument that can be issued by governments, corporations and municipalities. They are considered safe investments because the interest paid on the bond is usually fixed for its duration.
Bonds can provide steady income to your portfolio and make it more diversified as they allow you to invest in different types of investments like stocks, commodities or real estate without committing all your money at one time. The varying bonds offered by governments and corporations with varying maturation periods and interest rates make them a great way to diversify your investment portfolio.
Consider index funds
Index funds are considered as one of the smartest forms of investment. Adding index funds in your portfolio makes a wonderful long-term diversification investment for your portfolio.
Index funds often come with low fees that makes it very affordable, and provides very attractive returns. Mutual funds and exchange-traded funds (ETFs) are a great way to do this, because they give you access to a basket of investments that typically holds dozens or even hundreds of underlying stocks or bonds. Look for index funds that are well-managed, have a history of great year-on-year performance, and have high returns.
Adding alternatives like commodities, private equity, and real estate can enhance the overall return potential of a portfolio over time
Alternative investments such as commodities, private equity and real estate are not guaranteed to be successful. However, they can be used to diversify across asset classes and regions. In addition to adding alternatives like commodities, private equity and real estate as part of a portfolio’s overall diversification strategy.
There are many facets of diversification that you should incorporate into your investment portfolio;
1. Include multiple securities
While investing, it is advisable to include multiple securities. Not just investing in one or two stocks that you know or think will do really well, but adding many others to reduce the risk that if one stock does poorly, your entire portfolio does poorly. Consider talking to a qualified stock broker so you can acquire stocks that consistently perform well in the markets.
2. Diversify across major asset classes
Depending on your goals and risk tolerance, include stocks and bonds that have different reactions to the changing economy. This will reduce the volatility of your portfolio. Other asset classes such as fixed-income investments, cash and cash equivalents, commodities, real estate, and futures and other derivatives are great ways to diversify.
Each asset class moves in response to different market conditions, for different reasons so, the risk that each class is exposed are different, and so are the returns each one provides.
Ideally, when one asset class isn’t performing well, others are, and that might serve to protect your portfolio against those crashes that would “break all your eggs.”
3. Diversify Across Geographies
It’s not just about having different types of stocks in your portfolio—it’s also about including international investments so you’re never caught short if one particular stock or sector crashes.
International investments can help diversify your portfolio. Even while economy is becoming globalized, countries economies don’t all move in lock step with each other.
Investing in stocks and bonds from around the world will ensure that if anything happens with one country’s economy (or even something as simple as its currency), there are other places where people have money invested and won’t be hurt as much by its collapse or devaluation.
How Diversified Should Your Portfolio Be?
There’s no magic formula to tell you exactly how diversified your portfolio should be. However, the ideal portfolio is one whose investment returns aren’t correlated with one another. This way, if one economic event affects a part of your portfolio, it either doesn’t affect your entire portfolio, or it has the opposite effect on another part of your portfolio.
One fatal mistake you could make when investing is putting your money in multiple funds that invest in the same markets or hold the same assets.
It is important to remember that the appropriate level of diversification relies on your financial and investment goals, and your risk tolerance. Additionally, as these aspects change over time, so should the asset allocation in your portfolio. You don’t want to be nearing your retirement with your money tied up in long-term investments.
Also remember to regularly rebalance your asset allocation. As market conditions change, they affect the balance of your investments or asset classes in terms of monetary value. For example, when one investment does well over time, it represents a larger portion of your portfolio. When this happens, it may be crucial to buy or sell certain asset classes to restore the original asset allocation of your portfolio.
Start Diversifying Today
Spreading your investments across multiple asset classes not only minimizes your risk, it also increases your chances of great returns. They key to diversifying is understanding your financial goals and your risk tolerance, and picking investments that fit this profile.
For the best outcome when diversifying your portfolio, talk to an experienced stock broker or financial manager.