A well-diversified portfolio will make all the difference when building your long-term wealth. Disciplined investors in both the 1990s and in 2000s benefited from diversifying their portfolio when the market showed an unexpected turn for the worst. Reacting to a calamity in the market is always too late because by the time the news gets out, the damage has already been done.
6 TIPS FOR CREATING A WELL-DIVERSIFIED PORTFOLIO
- Invest in More Than One Asset to Build Your Investment Portfolio
- Invest in Different Securities with an Asset Class
- Invest in Index Funds for Portfolio Diversification
- Regularly Add Investments for a Well-Diversified Portfolio
- Rebalance Diversified Investments for Balanced Diversified Portfolio Returns
- Take Full Advantage of Your 401k
The best time to diversify your portfolio is long before it’s necessary. While there’s no guarantee against loss, diversification will significantly minimize your risk in the event of a recession.
1. Invest in More Than One Asset to Build Your Investment Portfolio
While holding equities is commendable, you don’t want to put all your funds in your favorite stocks or in only one sector of the economy, regardless of how well you have made your selection. Instead, you want to invest in a wide variety of asset classes. Don’t make the mistake of limiting yourself to familiar investments. Stretch yourself by taking financial classes, working with a mentor, and taking the time to learn about all the money investment options available for you.
Here are some ways to have a more balanced asset allocation:
Invest in Stocks to Build a Diversified Portfolio
Historically, stocks have yielded the highest returns for investors. Unfortunately, even a diversified stock portfolio is subject to volatility. Since a stock portfolio can carry great risk, you require risk tolerance. You could hit a home run with your securities, or you could also strike out. Stocks are especially unpredictable in the short run. Generally, the stocks of large, well-established companies and hedge funds have lost money over short-term investments, with investors sometimes experiencing significant financial losses. In the long run, however, good stocks have managed to ride out volatility in the market and have provided shrewd investors with a strong return.
The best way to do well with risk-adjusted returns from domestic or international equities is to work with a financial advisor, come up with a sound investment strategy, and diversify your portfolio. Of course, you also need realistic financial goals to calculate the time horizon of your investment returns.
Invest in Bonds to Build a Diversified Portfolio
Bonds are far less volatile, but also only offer smaller returns. The reason an investor might invest in bonds is to reduce the risk of holding too many stocks. While there are some bonds that offer high returns, even higher than stocks, these are classified as junk bonds. Although they offer a high yield, they also carry much higher risk.
Invest in Cash and Cash Equivalents to Build a Diversified Portfolio
Cash and cash equivalents—like money market funds, money market deposits, treasury bills, certificates of deposits, and savings—are both safe and amenable to fairly accurate forward-looking statements. While it’s hard to lose money with these assets, the amount you make on your return, accounting for inflation and the loss of purchasing power, is not enough for you to fantasize about getting rich anytime soon. For the most part, federal government guarantees restrict themselves to cash equivalents as a form of diversifiable risk.
Invest in ETFs to Build a Diversified Portfolio
Many investors who search for the most diversified portfolio find it convenient to invest in exchange-traded funds. ETFs are funds that are traded in the stock market. An ETF may consist of stocks, bonds, and commodities that are traded using an arbitrage mechanism. The best-diversified ETF portfolio will trade as close to its current net asset value as possible, although deviations can and do occur even in a diversified portfolio.
Invest in Other Assets to Build a Diversified Portfolio
Generally speaking, stocks, bonds, and cash usually form the bulk of a diversified portfolio. They are seen as a reliable basis for college savings or retirement savings. While there are other assets that you could add to your portfolio, there are category-specific risks associated with foreign exchange, private equity, futures, precious metals, real estate, and ETFs. All these asset classes require considerable subject matter expertise to turn a steady profit.
2. Invest in Different Securities with an Asset Class
You may want to consider varying the types of securities within an asset class. For instance, you could get different types of bonds—like Treasury bonds, US government bonds, high-yield bonds, investment-grade corporate bonds, foreign bonds, municipal bonds, and mortgage-backed bonds. Similarly, you may want to get shares from different size companies and from companies in different industries.
The basic idea here is to reduce how well your assets are correlated with each other. You can choose different asset types, different securities, multiple markets, different cycles, and even varied durations. You want to minimize the impact of any unexpected conditions to your overall portfolio.
3. Invest in Index Funds for Portfolio Diversification
Securities that track indexes will help you hedge against a volatile market and uncertain economic conditions. Since 2016, it is believed that one out of every five dollars invested was put into an index fund. Adding index funds to your financial portfolio will give you a new perspective on investing.
What is an index fund? An index fund is a list of stocks that have something in common. The Dow Jones Industrial Average, for example, consists of 30 blue chip stocks. Another index fund is the S&P 500 (the Standard and Poor’s 500). While the Dow Jones Industrial Average has been known for its stable predictability, the S&P 500 historical returns have attracted significant attention.
Although not much appears to be happening year-to-year, the S&P 500 has done well over a long period of time because of its compounding power. Started in 1957, it is now the most frequently mentioned index in the entire world. If you were to buy into the S&P 500, the financial experts at Standard and Poor’s would manage your individual stocks in a pool that they try to track as close to the index as possible.
4. Regularly Add Investments for a Well-Diversified Portfolio
Once you have determined your asset allocation and have your portfolio up and running, the next thing you must do is to keep on adding to your investments. The use of dollar-cost averaging will even out the highs and lows of your gains and losses and keep your money growing in aggregate.
Instead of buying individual shares or trying out independent investments, one easy way to keep on adding to your investments is to buy mutual funds. The approach makes it easy to automate investments, which, in turn, will make it easy to set up dollar-cost averaging. By automating the investment, expensive shares will not be purchased but cheaper-priced shares will be added to the portfolio.
5. Rebalance Diversified Investments for Balanced Diversified Portfolio Returns
Creating a diversified investment portfolio is no easy task. It takes time and effort to figure out how to build a perfectly diversified portfolio. Consequently, it can be upsetting when the market threatens to destabilize your well-diversified portfolio. Still, you must always be open to looking at your small-cap stocks and large-cap stocks to see if there are any disruptions to your returns.
Although there is much to say for buying-and-holding, dollar-cost-averaging, and automating the purchase of mutual funds, this does not mean that these strategies should be pursued regardless of what is happening in the marketplace.
There will be times when overall market conditions call for rebalancing an ideal diversified portfolio. You can only return your portfolio to a comfortable, tolerable level of risk if you are willing to quit buying assets that are no longer in alignment with your financial goals.
Suppose, for example, you continue to increase your biotech stocks to the point where they make up 70% of your portfolio. Eventually, your previously promising biotechnology companies are undermined by new inventions in the field. At this point, it would be more sensible to sell some of these stocks to reestablish your original allocation goals.
6. Take Full Advantage of Your 401k
Since there are many ways to invest and grow your wealth, it’s easy to dismiss the benefits of continuing to grow your 401k. If you are a working person, then you really should take advantage of your employer’s 401k plan. To pass on this because you are doing so well with your other investment is passing up on free money. If you make the effort to contribute to the amount allocated by your employer match, your employer will match you dollar for dollar on the first three percent of your contribution. Think about it: You are earning 100% on your funds without incurring any risk.
Creating a Diversified Portfolio
The aim of diversification is to maximize the return on your investments by choosing different markets that will react in different ways when economic events occur. Although diversification is not a guarantee against loss in a recession, it does serve to rationally minimize your risk. This, in turn, will increase your chances of reaching your long-term goals.
Once you understand the advantages of a diversified portfolio, then constructing a diversified portfolio can be an educational, enjoyable, informative, and profitable. In fact, one thing you may notice is that asset allocation and diversification come easily to you.
Regardless of your investment portfolio categories and asset class organization, your best-diversified portfolio is always open to revision. To do it well, you need to adopt a disciplined approach, diversify, and use buy-and-hold strategies to benefit from dollar-cost averaging. When you invest carefully, you will be rewarded even when everyone else is impacted by adverse market conditions.