8 Tips for Investment Diversification
Today’s market can change when least expected, which is why taking time to thoroughly plan your investments is recommended. Since market changes are unpredictable, focusing on establishing a well-diversified portfolio will help you enhance and preserve its value. Investment diversification is a crucial part of risk management, which can help to mitigate risk and may help to protect against significant losses during market swings.
What Is Diversification?
Financial planners, fund managers, and individual investors practice and encourage diversification because it’s a practical investment management strategy that blends various investments into a single portfolio. Diversification is effective because owning a range of varying investments or asset classes that do not move together at the same time (not correlated) can help to reduce portfolio volatility. They may reduce the risk of losing funds by investing in a variety of different markets rather than having all funds focused on a single market.
Diversification is not a new strategy for investing, and it’s essential to recognize the art behind the entire process. Whether you have been managing your investments for a while or are just getting started, choosing various asset classes with low or negative correlations can reduce portfolio risk.
So, how can you get started on establishing a diversified investment portfolio? Read on to learn about eight quick tips from our financial planning professionals.
Expand Your Funds
It’s vital to consider placing your money in various areas, from stocks and bonds to commodities and real estate. Utilizing this strategy will help you spread your risk and may result in a larger reward. Below are a few examples of the numerous asset classes that can be included in a diversified investment portfolio:
- Mutual funds
- Single stocks
- Index funds
- Cash and cash equivalents
- Real assets such as property and commodities
Regularly Add to Your Investments
Adding to your investments at regular intervals will help you continue to build your diversified portfolio. You can utilize many different strategies, but one that’s very popular and effective is dollar-cost averaging. Dollar-cost averaging will cut down your overall investment risk by routinely investing the same amount of money over an allotted time frame. You’ll establish an investment schedule so funds are invested regularly into your portfolio holdings. With dollar-cost averaging, you will also purchase more shares when prices are low versus when prices are high.
Consider Index or Fixed-Income (Bond) Funds
Investing in index or fixed-income (bond) funds will allow you to track various indexes. Index and fixed-income (bond) funds try to match the performance of broad indexes that reflect a specific market’s returns. Adding index funds or fixed-income (bond) funds to your portfolio is one way to add diversification to your portfolio. These funds also tend to come with low fees and management and operating costs, meaning more money for you – plain and simple. Learn more about each type of fund below:
- Index fund: Investing in index funds typically offers low operating expenses, broad market exposure, and low portfolio turnover. Index funds are a type of mutual fund or exchange-traded fund (ETF) that is designed to match or track common components of a financial market index.
- Fixed-income fund: Also known as bond funds, fixed-income funds are mutual funds that are invested solely in bonds and other debt instruments. The primary goal of fixed-income funds is to generate monthly income for investors.
Account for Change and Required Fees
Once you make investments, the work doesn’t stop there. You must stay informed about your investment, be aware of overall market conditions, and understand any required monthly or transactional fees. Take time to account for changes in both company and market conditions, as well as any required fees, so you can remain aware and informed of the status of your returns.
Vary Sizes and Types of Companies
While it’s important to diversify your portfolio between asset classes, it’s also recommended to diversify within each asset category. For example, you’ll likely have a mix of stocks, bonds, real estate, commodities, and cash. So, with consideration to each of these asset categories, you should also focus on investing in companies and bonds that vary in type and size as this may help to further diversify the portfolio holdings.
Investment portfolios need to be maintained, meaning diversifying your portfolio once isn’t enough. While many rebalance their portfolios annually, it’s recommended to review portfolios on a quarterly basis to determine if rebalancing is desired. Over time, some of your investments will gain value, while others lose value. When this occurs, you’ll simply reallocate funds from those that have gained value to those that have underperformed. Rebalancing helps your portfolio during both market highs and lows. It’s also essential to account for different situations that might trigger rebalancing, such as market volatility or a major life event.
Include Global Market Exposure
It’s highly recommended to consider investing in foreign stocks and bonds as this can increase the diversification of your portfolio substantially. Having exposure in global markets could help you continue to get returns, even when the U.S. markets are weak. If you’re only investing in U.S. securities, your entire portfolio is subject to U.S.-specific risk, whereas investing globally will diversify your portfolio risk in multiple countries. Country-specific risks include foreign taxation, political and economic development, currency, and more.
Consider Overall Risk Tolerance
Assessing and considering your risk tolerance is vital as this can impact your approach to diversification. In most scenarios, you can weather more short-term losses to potentially capture long-term gains if you have a longer timeframe.
- Aggressive. These investors often have a timeframe of 30+ years, meaning they have higher risk tolerance. Typically, 90 percent of their funds are allocated in stocks, while the other 10 percent is in bonds.
- Moderate. These investors often have a timeframe of 20 years before needing access to their funds. Typically, a lower percentage of their funds are allocated in stocks when compared to an aggressive investor.
- Conservative. These investors may have a timeframe of fewer than 10 years in which they’ll need to access their funds. Typically, they allocate 50 percent of their funds in stocks and 50 percent of their funds in bonds.
Work With an Investment Advisor Today
Investing can be interesting and fun, especially if you learn how to do it correctly. Whether you’ve been contributing funds to an investment portfolio for a while or are seeking guidance to get started, working with an investment professional can be beneficial. You’ll learn how to approach investing in a disciplined manner through diversification and other useful strategies. If you’re ready to explore the potential rewards from your investments, we encourage you to contact the investment planning professionals at Affiance Financial today.
Please Note: There are no assurances that the content made reference to directly or indirectly in this blog post will be profitable, or suitable for your individual situation, or prove successful. Due to various factors, including changing conditions, the content is only reflective of current opinions or positions and is subject to change at any time and without notice. Moreover, you should not assume that this article serves as the receipt of, or as a substitute for, personalized investment advice from Affiance Financial. Please remember to contact Affiance Financial if there are any changes in your personal/financial situation or investment objectives.