You’ve heard the saying “don’t put all your eggs in one basket.” Diversifying your investments mitigates risk and can help you get closer to your financial goals.
It’s important to diversify across different asset classes, like stocks, bonds and cash alternatives. It’s also helpful to diversify within each class, such as dividing stock holdings by industry. Check out diversify your funds now!
Stocks
A core asset class for building wealth, stocks offer the opportunity to participate in companies’ growth. However, stocks are not without risk and can decline in value.
Diversification helps minimize risk, as different industries and regions thrive at different times. By spreading out your stocks, you may mitigate some losses when the stock market falters.
For those who don’t have the time to research individual stocks, exchange-traded funds and index funds are popular diversifiers that allow you to invest in a group of stocks. In addition to offering greater diversity, these investments can provide lower fees than individual stock purchases.
When it comes to bond diversification, you can look at investment-grade corporate bonds, municipal bonds and U.S. government bonds. You can also choose from different term lengths, interest plans and credit quality.
Bonds
Bonds add an element of stability to any diversified portfolio and can help offset losses from declining stock prices. However, they don’t protect against all risk and may have a lower return potential than stocks.
Investors can diversify bonds by size (large-, medium- and small-cap) and by location (domestic or international). They can also find a variety of maturities. Bond funds (mutual funds or exchange-traded funds) can simplify the process of adding different types and series of bonds to a portfolio.
A well-diversified bond portfolio has a low correlation with stocks, which reduces overall volatility. But diversification reduces a portfolio’s expected return, so investors should consider their investing goals and tolerance for risk before making changes to their asset allocation.
Money Markets
Money market mutual funds are a good place to hold your short-term savings. They offer high liquidity and low risk, with the potential for higher yields than standard savings accounts.
However, money market funds typically have lower long-term returns than stocks. This trade-off is an expected part of their lower-risk profile.
Some funds may also be at risk of “breaking the buck,” which means that the net asset value drops below $1 per share, such as in 2008 during the financial crisis. This scenario is relatively rare, but it can happen.
A diversified investment portfolio should include a mix of stocks, bonds and cash. A trusted financial professional can help you choose the right investments for your goals and risk tolerance. You can purchase money market mutual funds through a brokerage or financial services firm and they generally have an expense ratio. Some funds invest in municipal securities, which can provide tax advantages at the federal and state level.
Real Estate
Real estate is a good addition to your portfolio, because it provides income and diversifies by asset class. You can invest in individual property or real estate investment trusts (REITs). A REIT has stock-like returns but generates passive income from the ownership of properties, and can help diversify by location.
Diversification doesn’t protect against losses, but it can reduce the chance of large swings in your portfolio’s value. By diversifying your investments, you may also have more opportunities to realize gains.
A well-diversified portfolio can include stocks, bonds, cash, real estate and international securities. It’s best to divide these categories into smaller segments to manage your risk more effectively. For example, you might consider dividing your stock allocation into small-, mid- and large-cap companies. You could also split your bond allocation into municipal, corporate and Treasury bonds. And for the international category, it’s important to spread your investments across both developed and emerging countries. This diversification helps reduce currency risk.