Diversification is key to any effective investment strategy, and here’s how you can diversify your investments to balance risk with reward.
Diversification can help mitigate overall portfolio risk. The goal should not be over-diversification.
Sectors
Diversifying an investment portfolio requires investing across various sectors; otherwise, its returns will become too concentrated over time. Furthermore, diversifying by company size, creditworthiness, investment strategy and location is crucial.
Bond investing is one of the easiest and most reliable ways to diversify an investment portfolio. There are different kinds of bonds – corporate, treasury and junk bonds among them – each offering different lengths of time and rates of return; you can even layer risk by including low-, medium- and high-risk options in your mix.
Diversification doesn’t guarantee returns or protect against losses, but it can help mitigate some risk. It is wise to review your portfolio periodically throughout the year and rebalance as necessary, otherwise strong performers could become too large of a portion of it while weak performers might lose ground too quickly – leaving your investments off-track from meeting their long-term goals.
Size
Stocks, bonds and short-term investments form the core components of a portfolio. Many investors use funds that track broad market indices like S&P 500 to build an inexpensive yet well-diversified portfolio quickly.
Diversifying by industry can also help mitigate company-specific risk. For instance, if your portfolio consists largely of energy stocks and their prices decline precipitously, multiple companies could experience losses simultaneously; but by diversifying into other sectors as well, their losses would be mitigated more than otherwise.
Diversifying across asset classes such as bonds (corporate or treasury), duration and bond issuer is also advised as this will allow your investments to provide some protection in case one loses value while others make gains and your overall returns will increase.
Emerging Markets
Diversification refers to diversifying your portfolio among various assets, such as stocks, bonds and even alternative investments. Diversifying helps reduce risk while simultaneously increasing the chances of higher returns.
Implementing the ideal diversification strategy requires taking an honest appraisal of your financial circumstances, goals and risk tolerance. With this information in hand, an appropriate asset allocation will emerge that shows you exactly how much should be invested in each asset class.
Diversifying within each asset class is also key, such as diversifying market capitalization, geography and sector for stocks; or bond maturities, credit qualities and durations for bonds.
Diversifying your portfolio even further requires investing in funds that track different indexes as well as fixed income solutions like mutual or exchange-traded funds. Over time, investments may fluctuate based on how they perform in your portfolio, so meeting with an investment professional and rebalancing it regularly are both key tasks to maintaining success in investing.
International
Diversifying your investment portfolio means spreading out your funds across various asset classes – stocks, bonds, real estate and commodities. Doing this helps mitigate risk while increasing future returns by not placing all your eggs in one basket.
Diversifying investments within each asset class means diversifying among companies of various sizes (large-cap, mid-cap and emerging markets), sectors and maturities and credit qualities – for instance if investing in bond mutual funds consider incorporating both corporate and treasury bond funds with differing maturities and credit qualities into your portfolio.
Savings accounts, money market accounts and certificates of deposit can provide further diversification by offering lower returns compared to stocks but providing stability should the market take a tumble. Furthermore, short-term assets tend to have low correlations between them and stocks.
