“Don’t put all your eggs in one basket.” It’s a phrase well-known when it comes to risk management, especially when it comes to investing. Any investor knows that the key to healthy, successful investing is to diversify your portfolio – but what exactly does that look like, and what should you watch out for?
While it may sound intimidating, portfolio diversification is all about protecting your capital. Choosing different classes of assets from different industries among other variables will not only help maximize the return on your investments, but it will also reduce your overall risk.
Whether you are a first-time investor or you’re just rebalancing your existing portfolio, here are the top six things to keep in mind as you’re diversifying your investments:
Classes and trends.
Having a blend of stocks, bonds, cash, mutual funds, and alternative investments is the best way to start. Mutual funds, as well as exchange-traded funds (ETFs), are popular as well since they already come diversified by investing in multiple assets through a single channel. Some of these options are more volatile, some take a longer window for returns, and some require additional fees – so make sure to do your research or consult a financial advisor before you buy.
Even across different asset classes though, pay attention to the trends – do many or most of your assets seem to trend in a similar fashion? In that case, that’s not very diversified. Look at other variables, such as…
Trying different industries.
Although there’s something to be said for “buying what you know,” that can often lead investors to get stuck within a single sector, particularly with retail. Do a little browsing and research starting with what you know, and branch out to explore companies and industries you may not have initially considered.
Time horizons and goals.
It’s easier to know what to look for in an investment once you have a financial goal in mind, such as a specific retirement time frame. You don’t want to invest in something that takes far longer to pay off the way you intended – nor do you want to take a bigger risk on volatile investment options when you could actually earn more on something with a longer return and higher interest. Balancing long term and short term investments can help diversify your portfolio while adjusting to your goals. Setting these goals will help you with your investment strategy, especially when it comes to…
Ensuring you have a balance of low-, medium-, and high-risk investments isn’t just good for diversifying – it can also optimize your return potential. You will need to decide whether or not you would consider yourself an aggressive, moderate, or conservative investor, and invest at that comfort level.
Your goals and time frames from the previous point will come in handy here, especially since younger investors are able to take bigger risks in more volatile markets to potentially maximize higher returns over time. If you need faster access to your money, however, a more conservative approach may be necessary.
Beware of over-diversifying!
Diversification is important, but remember that you only have so many resources and so much bandwidth. Over-diversifying could stunt your returns, increase transaction costs or fees, and end up costing you more on your taxes. Don’t spread yourself (or your assets) too thin, make the decisions based on what you can commit to within your budget. In a volatile market, investing can be even more of a gamble, so make sure to be selective!
Consider alternative investments.
There’s more to investing than standard stocks, bonds, cash, and mutual funds – although they can offer varying levels of liquidity. Certificates of deposit (CDs), real estate, collectibles, and commodities are some of the more common alternative types of investments that can help investors build a diversified portfolio.
For an investment with a rapid ROI, investing in an ice and water vending machine could be a great way to diversify as well as start earning low-risk passive income – because no matter what’s happening in the stock market, people will always need fresh ice and filtered water.
There are several factors to consider throughout the investing process, and variables that are going to change – both within your personal finances, as well as the market. Always make sure to regularly rebalance your portfolio to manage risk and make the most of your investments.