Most people would rather save their money in a bank somewhere than invest, mainly because of the risks associated with investing. Many dread the thought of risking their hard-earned money until they understand one of the most basic and effective risk management techniques – diversification.
The rationale behind diversification is simple – on average, investment portfolios composed of different kinds of investments yield higher returns and pose a lower risk compared to any individual investment within the portfolio.
Here are four steps to start bringing more diversity to your portfolio:
1. Have Different Investments In Your Portfolio
ETFs & Mutual Funds – An effortless way to do this is by purchasing ETFs, index funds, or mutual funds. ETFs and mutual funds act as a basket of different stocks—giving you instant diversification. They trade differently, so you’ll want to read about each in detail before buying them, but they’re an excellent method to diversify without getting overly complicated.
Index Funds – Index funds are another excellent option—as they include stocks that mirror a specific index—such as the S&P 500. Your diversification may be a little more limited here, but it’s still a sound option to consider.
A properly diversified investment portfolio should include: Cash, Stocks, Bonds, Exchange Traded Funds, Mutual Funds
2. Diversify Within Diversification
Pick investments with different rates of returns – this becomes more challenging when you’re buying individual stocks since you’ll want to invest a decent amount to make the cost of trading worth it. For example, you don’t want to spend $10 to buy one share of stock for $200. You should invest a more substantial chunk, so you save money on fees. Because of this, many people end up with a handful of stocks in their portfolio, putting them at risk.
So when investing in stocks, for instance, don’t concentrate on a single stock or a few stocks but rather, different stocks in different sectors. It’s also essential to have stocks with mixed-income, growth, market capitalization among other metrics. When investing in things like bonds, consider bonds with different credit qualities, duration, and maturities.
3. Have Investments With Different Risk Levels
Choose investments with various rates of return – when diversifying your portfolio, pick different investments whose rate of return is different to ensure substantial gains for certain investments offset losses in other investments. Remember, although the intention is to minimize risk, you aren’t restricted to blue-chip stocks only.
Foreign stocks. A good methodology to use here is to look at foreign stocks. Stocks from other countries tend to perform a little differently and typically balance out a domestic-heavy investment portfolio nicely. You can also look at small-cap or mid-cap stocks, which are younger, and more volatile stocks.
4. Rebalance Your Portfolio Regularly
Contrary to popular belief, diversification isn’t a one-time task. You should check your portfolio often and make changes accordingly when the risk level isn’t consistent with your financial goals or strategy. We recommend meeting and rebalancing your portfolio at least two times per year.
Diversifying reduces the uncertainty of investing. There is a level of uncertainty in every financial market. If you put all your money in stocks, you risk losing everything if the stock market crashes. The same applies to the real estate market, commodities markets, currencies, and any other investment. However, all markets hardly crash at the same time, in the same manner.
The same applies to investments in the same asset class. For instance, two stocks of different companies in different sectors fluctuate differently. By diversifying, which is just putting your money in various investments across different sectors, the probability of losing a significant amount of money or your entire investment is very low.
Diversification will reduce risks and make your returns more stable over the long-term. If you would like a complimentary review speak with an expert today.
