What It Means To Diversify Assets and How To Do It
What Is Diversification in Investments?
The idea behind portfolio diversification is to spread out your investments in a variety of assets rather than just one. This includes a mixture of stocks, bonds, Certificates of Deposits and international investments. Stocks carry a higher risk while things such as bonds and CDs have lower risk.
Thinking of the roulette table at a casino can help you understand the concept of diversification better. Some players put all of their money on a single number, such as “red 19.” This offers maximum payouts but a huge risk. Betting on “all red” instead promises lower returns but a safer investment since any red number between 1 and 38 means you win.
Why Diversifying Assets Is Smart
A diversified portfolio offers proven benefits:
• Lower investment risk: Low-risk investments tend to grow slowly but surely over time. In the case of many CDs, your investment is actually guaranteed by the federal government.
• Higher long-term gains: A mix of assets tends to provide stable profits over time. This is especially true if you invest in bonds, money market options and stocks known for stability, such as commodities.
• Better protection against market instability: In a diversified portfolio, you have a range of safety nets to help you minimize losses and encourage gains.
These advantages are a great fit for families who don’t have a lot of money to lose. This includes many small business owners and working middle-class parents like me.
How To Diversify an Investment Portfolio
The subject of diversifying investments is complex enough to need its own article (I will write an in-depth guide a little further down the line). Here are three tips that can get you started well:
1. Check out exchange-traded funds and mutual funds: These funds essentially take care of diversification for you. For each ETF share you buy, it’s like you’re investing in hundreds of different stocks. This option is excellent for someone who has little time for
micromanaging investments.
2. Choose a wide range of investments: Don’t go with just bonds. You need some stocks in the mix, too. Avoid investing in a single sector (such as all retail or all digital businesses). Spread the love and your portfolio will love you back. Select at least 12 different stocks and a max of 20–30.
3. Include negative-correlation investments: The goal is that while one investment loses
money, its opposite stock should rise. This is what happens with global stocks and bonds, for example. Any time the government slashes interest rates to encourage a floundering
economy, bonds benefit greatly.
Deciding the balance of low-risk and high-risk investments in your portfolio is one of the most important decisions you can make. The right choice depends on when you need the money. Choosing wisely ensures you have savings for your child’s college fund or to give you something extra for your nest egg.
What Diversification Isn’t
To completely avoid risk, you’d have to see the future. No one could have predicted the outbreak of the coronavirus and its impact on the global economy. Still, diversification can enable you to come out ahead in the long term. If part of your portfolio included investing in biotech or e-commerce, then those gains could help offset some losses in other sectors.