Putting all of your money into one company’s stock - or all your eggs in one basket - is a huge risk when it comes to investing. This is why diversification is key when it comes to having a successful investment portfolio.
As with many things in the financial world, diversification can seem tricky at first, but it helps reduce many investment risks.
So, what do you do if you’ve put all your eggs into one basket, and you’ve started to lose money? The simple answer is to diversify! Investing in assets that don’t move in the same direction or at the same pace significantly reduces your risk of losing all of your funds at once. Continue reading to learn more about what diversification actually means and different strategies to building a successful investment portfolio with NJM Wealth Preservation Strategies.
What Does it Mean to Diversify Your Investment Portfolio?
Diversification is the practice of investing in a variety of asset types. The primary purpose of this practice is to reduce the volatility of your portfolio, as well as reduce the risk of one asset affecting your entire portfolio at once.
How Do I Diversify?
There are two basic strategies for diversification; diversifying asset classes or diversifying within asset classes. Diversifying across asset classes, you’re spreading your investments across multiple asset types, such as stocks, bonds, real estate, etc. Diversifying within an asset class involves spreading your investments across multiple investments within the same asset type. For example, rather than buying stock in a single company, you buy stock from many different companies across different industries.
Time is another factor that should be considered in diversification. If your time horizon is fairly long, you may be able to take on greater risk in the pursuit of long-term growth. When you have a higher risk tolerance, you may be able to have a less-diversified portfolio. Alternatively, if your time horizon is shorter, you may want to reallocate assets to reduce your exposure to higher-risk investments and add more conservative ones such as bonds or money market funds. Basically, the closer you get to retirement, the more stable and low-risk your portfolio should be.
Different Investment Vehicles to Consider:
Stocks are generally the most aggressive investment type, providing the greatest growth opportunity over the long term. However, the greater the growth opportunity, the greater the risk in the short term.
Most bonds provide regular interest income and are less volatile compared to stocks. They can also be a nice cushion against the unpredictable ups and downs of the market. Although, many bonds don’t offer very high long-term returns.
Money market funds and short-term certificates of deposit (CDs) are the most common short term investments. Money market funds are one of the more conservative investment types, offering stability and early access to your funds. Just as bonds, this type of investment doesn’t provide high long-term returns. A CD is a savings product that earns interest in a lump sum for a fixed period of time. CDs are also a safer investment option than stocks and bonds, offering a non-volatile guaranteed rate of return.
While sector funds invest in stocks, they’re focused on a specific segment of the economy. Because of this they can be valuable tools for those seeking opportunities in different phases of the economic cycle.
A few other investment options include real estate funds and REITs (real estate investment trusts). These types of investments can provide some protection against the risk of inflation.
Asset allocation funds can help serve as an effective single-fund strategy for those who don’t wish to fully diversify their portfolio. The asset allocation of the fund can be fixed or variable among a mix of asset classes, meaning it may be held to fixed percentages of asset classes or allowed to go overweight depending on market conditions.
How to Choose the Right Investments for You:
When it comes down to it, the appropriate diversification for your portfolio ultimately depends on your risk tolerance, time horizon and financial goals. Your asset allocation should adapt & change with these aspects over time. Balance is key when it comes to investing. Being on the extreme end of either spectrum can cause imbalance that, if correctable, will come at a cost.
Before you start investing, it’s important to create a comprehensive financial plan and evaluate your risk tolerance. It is beneficial to consult with a trusted financial advisor.
If you’re looking for a true retirement income financial professional, NJM Wealth Preservation Strategies can help. If you’re ready for control of & balance within your portfolio, schedule a call with us here today.
Learn more about our Wealth Management Services here.