6 Easy Tips for Building a Diverse Investment Portfolio
Portfolio diversification is a common term for many financial planners, fund managers, and individual investors. It’s an investment strategy that involves including many different types of investments in a single portfolio.
Spreading out your investments across different sectors can help mitigate risks and yield higher rewards. The idea behind the strategy is fairly simple: if you own stocks in several different industries, even if one is seeing a decline, another could be seeing significant gains. So, your portfolio will still increase in value.
What does portfolio diversification look like?
A diversified portfolio contains stocks across different industries, countries, and risk profiles. A well-diversified portfolio will also include investments like bonds, commodities, and real estate.
The overall goal in diversifying your portfolio is to reduce your overall risk profile. By containing a variety of assets, your portfolio works to reduce your risk of a permanent loss of capital and overall volatility.
Conventional wisdom is to build a 60/40 portfolio, with 60% going towards stocks and 40% to fixed-income investments like bonds.
The key to a diversified portfolio is owning stocks in a wide variety of industries such as tech, energy, healthcare, as well as stocks from other industries. You don’t need exposure to every single sector, but variety is key.
You should also consider holding some investments that don’t ebb and flow with daily market fluctuations. These are called non-correlated investments. They include bonds, CDs, gold, and real estate.
Diversify your portfolio with 6 tips
Diversifying your portfolio isn’t as hard as it might sound. Here are 6 steps to help get you started.
1. Invest in multiple stocks and sectors
By putting all your money in one stock or sector, you’re significantly increasing your risk profile. Instead, consider investing in a handful of companies you know and trust. Consider companies you use in your daily life.
Look beyond stocks, too. You could also consider exchange-traded funds (EFTs), commodities, and real estate investment trusts (REITs).
Don’t spread yourself or your portfolio too thin though. If you don’t have the time or resources to keep up with 100 different investments, it could hurt you in the long run. Try to limit that number to 20 or 30, or whatever you think is manageable.
2. Include low-fee index funds
You might want to add some index funds to your portfolio. Securities that track various indexes can be a great long-term diversification investment.
Index funds often come with low fees because you’re not paying for the expertise of a fund manager to hand-pick investments for you.
However, most of these indexes are passively managed, which can be a potential drawback. So, if there is a decline in the market, the index fund may not adapt quickly enough.
3. Consider bonds
Investing in fixed-income assets like bonds can help reduce your overall risk profile, since these types of investments don’t ebb and flow with daily market fluctuations.
It’s true that adding some bonds will likely reduce your portfolio’s average rate of return. But it’s also true that they tend to reduce losses in bad years and reduce the number of years with an overall loss.
4. Invest regularly
Try to invest on a regular basis. Figure out how much you can afford to invest and consider a dollar-cost averaging approach.
The idea behind this approach is to cut investment risk by investing the same amount of money over a period of time.
With dollar-cost averaging, you invest money on a regular basis into a specific selection of stocks. With this strategy, you’ll buy more shares when prices are low and fewer shares when prices are high.
5. Know when to sell
Automating your investment strategy can save you time, but it can also cost you if you’re not actively paying attention to the market.
Stay current with your investments and with any changes in overall market conditions. Know what is happening in the companies you’re investing in.
If a particular stock is seeing significant declines, it might be time to cut your losses and move on to other investments.
6. Watch out for fees
Know what you’re paying in brokerage fees and what you’re getting out of them. Some firms charge transactional fees, while others charge a monthly fee.
Fees can add up over time and can chip away at your overall gains. Make sure you pay attention to any changes in your fees.
And remember, the cheapest option is not always the best. When paying fees on your trades, make sure you’re getting what you pay for.
Diversifying your portfolio is about trade-offs. A successfully diversified portfolio reduces your overall risk profile, but it can also affect your return potential.
Eliminating volatility in your portfolio and reducing the risk of total loss of investment is a high yield reward in its own.
If you’d like to learn more about investing, we have some quick and easy resources in our free Financial Education Center.
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