“Don't put all your eggs in one basket” is sage investing advice. It advises the investor to think about where they invest their money and what kind of overall portfolio they're building. In other words, if you're investing, make sure to diversify and invest in different stocks and assets. Diversification is essential to any successful investment strategy. Diversification provides an opportunity for both protection and growth within your investments. Here's our how to diversify a portfolio guide.
What Is Diversification?
Diversification refers to the practice of buying different types of assets. These different assets make up your portfolio.
Diversification can be done in many ways, which we'll get to in a moment. But the most important part of having diversified investments is that it provides some protection for your portfolio.
If you put all your eggs in one basket and that basket gets knocked off the table, all your eggs will break. If you had put only half your eggs in that basket and put the other half in a carton in the refrigerator and the basket fell off the table, you'd still have half your eggs safe in the fridge.
It's the same thing for your investments. If you invest solely in stocks and the market tanks, you could lose everything. Diversification means that any catastrophic loss in one area won't wipe out all your investment holdings.
How Can You Diversify Your Investments?
Creating a diversified investment plan isn't the same for everyone. What works best for you will depend on several factors, like age, gender, retirement goals, and income.
To start, you should understand what types of assets you're interested in investing in. When it comes to the stock market, there are a lot of choices, but the three main ones are:
Stocks — Partial ownership in a company
Bonds — Loans investors make to entities like a government or a company
Commodities — Products, such as wheat or gold investing.
To take diversification one step further, you can also diversify even within one asset class. Take stocks, for example. You have the option of buying a mutual fund or a single individual stock. You can buy Nike stock, and you can buy a mutual fund. Now you have two different types of stock holdings. If Nike goes bankrupt, you will lose money in that holding, but you would still have your mutual fund investment.
Spreading your investments across each of these asset types is just one way to diversify your investments. The following are some other examples of diversification.
1. Asset Allocation
One of the easiest ways to diversify is with asset allocation. You can use an asset allocation fund that uses a predetermined percentage of stocks and bonds. For example, a 60/40 fund invests 60% in stocks and 40% in bonds.
These types of allocations are based on modern portfolio theory. They are considered best in a buy-and-hold strategy. You can find out more about the best asset allocation strategy for your needs by talking to a financial advisor. If you don't have a financial advisor, you can use the Paladin Registry platform to find one that is best for you.
2. Invest in a Mix of ETFs and Mutual Funds
Investing in a mix of different exchange-traded funds (ETFs) or mutual funds allows you to tailor your investment portfolio. ETFs and mutual funds are generally more diverse than buying one or two stocks.
You should invest your money in at least five different ETFs or funds. Make sure not to have more than 25% of your money in any one of them. That way, you can spread your risk across different asset classes. At De Angelis & Associates, we recommend you check out Merrill Edge for ETFs and Mutual Funds Investing, as it provides insightful online tools to help users better manage their investments.
3. Invest in Foreign Companies and Assets
Most investors are inclined to invest only in domestic assets. But if you want to diversify your portfolio truly, make sure to invest in international markets as well. While the United States is the biggest country in terms of market capitalization, global companies play an essential role in the markets. And it's good to have some exposure to other markets.
4. Vary Your Investments by Company Size
In addition to investing in different assets, you should also invest in different company sizes and types. You could do this by buying a mix of stocks from bigger companies, as well as a few lesser-known companies. You can also hold stock in different industries, such as health care, energy, or retailers. Also, keep in mind the risk and maturity of a company. A company that just issued an initial public offering (IPO) might have the best potential for return, but it also could have a huge risk of its stock falling. If you do invest in a risky stock, make sure to balance it by investing in a more mature stock or asset class.
Diversity Is Still the Safest Investing Strategy
Diversifying is easier than it sounds, and each investor can diversify their investments however they want. Building a diversified portfolio is a way to protect your investments and gives you an excellent chance to find a growing investment. Take into consideration all your financial goals and present situation, and build a diversified portfolio that works for you.
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