When investing, it’s important not to put all your eggs in one basket. Risk management and understanding various asset classes are significant parts of successful investing. Yet before diving into investments and their asset classes, it's crucial to establish healthy financial habits. This means paying off debts and allocating funds for ongoing expenses, recreational spending, and emergencies. Starting with just a few dollars a month can put you on the path to building a diversified portfolio.
In this blog, we will delve into the intricacies of determining the right level of diversification, navigating high-risk assets, and, ultimately, building a diversified portfolio suited for you. The process can’t eliminate investment risk, but it can help reduce the risk to your portfolio.
Why diversify?
Investment diversification can help investors achieve the proper balance between growth and risk. A diversified portfolio can help safeguard against market volatility by incorporating different asset classes. This means spreading investments across stocks, bonds, mutual funds, exchange-traded funds (ETFs), and specific industries and market sectors. The key to doing this is to mitigate risk and increase the potential for returns.
How do you know if your investments are adequately diversified?
Your age, risk tolerance, and personal situation should play a role in determining your asset allocation strategy. Some assets include mutual funds, individual stocks and bonds, real estate, and cash. If you are adequately diversified, your portfolio should be tailored based on risk tolerance, investment horizon, and other factors.
If you are a conservative investor, maybe your portfolio is comprised of ETFs and real estate or real estate investment trusts (REITs). If you are an aggressive investor, your portfolio may include growth funds and individual growth stocks. If you are a speculative investor, you may invest in high-risk “junk” bonds or cryptocurrency.
When it comes to naturally diversified investments, not all are created equal. Certain investments, such as ETFs and REITs, inherently offer diversification across various asset classes and commodities. Typically, the more passive an investor you are, the more varied your investments should be to spread risk effectively.
It’s important to remember there’s no “right” answer. It's about determining your strategy and aligning it with your financial goals. The number of investments in your portfolio should depend on your timeline, financial goals, and personal preferences. Quality over quantity is critical, and finding a balance that aligns with your ability to monitor and manage your investments is paramount. When thinking about this, remember that you must review your assets at least once a year.
Suppose you feel uncomfortable monitoring numerous stocks, ETFs, mutual funds, and other investments. In that case, you can find diversified portfolios with just a few of these that have the potential to achieve similar results.
Is it always beneficial to diversify your portfolio?
Some people have different objectives and risk tolerance. So, what is suitable for someone else might not be suitable for you. A diversified portfolio can be challenging to monitor and manage if there are too many holdings. It can also be more expensive because of additional fees incurred with some investments.
Of course, diversification can help a portfolio as well. Depending on the market conditions, it might help mitigate losses. Different investments perform differently during periods of economic uncertainty. It’s also important to note diversification can help preserve capital for older investors in or near retirement.
How do you develop your diversification strategy?
The first step is to assess your situation. Look at factors such as age, the time until you need the money, your goals, and your risk tolerance. Financial services websites offer asset allocation tools to help you decide how much to allocate to stocks, bonds, and other asset classes. However, a financial advisor might be able to leverage additional tools, knowledge, and experience to help you properly diversify your portfolio based on other details relating to your situation.
What are high-risk investments?
As with many things, greater rewards often come with more risks. Certain high-risk investments may not align with your financial goals or lifestyle. Cryptocurrency, for example, is considered speculative and comes with considerable risk. Thoroughly researching and understanding the risks associated with various investment options is crucial. Speculative investments such as cryptocurrency and certain stocks offer the potential for higher returns. Consultation with a financial planner can be essential in determining whether they are a fit for you.
What should you do next?
Throughout this blog, we provided insight into the importance of diversification and outlined some factors to consider. Whether you are interested in diversifying globally, across industries and market sectors, bond types, or the other options we discussed, you must evaluate your current situation and future goals. If this overwhelms you, there are tools designed to help.
Awareness is key in every aspect of our lives. Simply reading this blog and understanding the need to consider diversification brings awareness to one of the most critical parts of your investment strategy. The first step might include a basic review of your financial situation, an in-depth review of your investments, or a professional consultation. Remember, you are investing in yourself, so do what is best for you.
To start your diversification journey, contact a Marsh McLennan Agency Retirement & Wealth Consultant today, and let’s start building a limitless future together.
