Diversification is a way to achieve variety across your portfolio. In personal finance and investments, portfolio diversification is significant. It is a risk management process in which you spread your investments in different assets.
You get better exposure and less risk in your investment portfolio. Let’s take a look at how proper portfolio diversification can help you achieve your goals.
Importance Of Diversification:
Let’s take a look at an example:
Jack and William both are doing well in their careers and earning $100,000 each year. Jack is investing this income into three different investments while William has only one stock.
Recently, the stock market has been volatile and William’s one year return has been depleted. That was his only source of investment, right?
On the other hand, Jack is putting his money in mutual funds, stocks, gold, and alternative investments as well. Like Jack, you can also ensure that you invest correctly. William took the easy way of diversifying his portfolio by putting his income into a single stock.
Relying on a single investment is a very high risk.
What happens if the company you invest in goes under? You lose money.
Investments can go through wild swings every day. That’s why you need to prepare yourself through multiple resources.
How To Diversify Your Investment Portfolio:
Now, taking the example above, let’s see how you can diversify your investment portfolio.
The four types of investment funds in which you can invest.
- Growth And Income:
These are the types of funds that bundle stocks of developed and multinational companies. Here you can earn your money with minimal risk. With income investing, you won’t earn as much of a return as the other funds offer. It is used to supplement income in retirement and minimize risk.
These are the stocks of growing companies offering more income to the investors but less than the aggressive growth funds. These stocks typically do not pay a dividend. Instead, they rely on investing their profits for future growth.
- Aggressive Growth Funds:
Without a doubt, these funds have the highest risk, but when it comes to income, these funds give you the best financial advantage over the long term. It’s a fantastic offer of those companies that have high potential growth, but they are currently establishing themselves.
During an expansion, high growth stocks can see their shares skyrocket. On the other hand, during a correction, high growth stocks will be the hardest hit. Due to the fact they usually have more debt than cash and will have a harder time weathering the storm during an economic downturn.
Another simple type is the international funds that you can invest in companies inside and outside of your country.
Building Your Portfolio
Many Financial experts agree that putting your first $10,000 of your retirement account into an index fund. After this initial contribution, you can start investing in individual stocks.
According to Robert Snow, Certified Financial Planner® with Morgan Stanley based in Houston, Texas.
“Portfolio diversification is a sound long term strategy to grow your wealth. It allows you to better absorb any economic downturn and capitalize on global expansion.”
To diversify your portfolio, you should invest in a mix of asset classes to ensure a better future for yourself and protection against the risk.
Things To Remember When Diversifying A Portfolio:
It’s important to understand that the example, as mentioned earlier, may seem easy to understand, but financial planning is not easy. You must understand the market and the company you invest in.
If you invest blindly, you run the risk of financial losses. It is recommended that you seek the advice of a financial professional that will take the time and explain the risk vs. reward of each investment.
For most people, the time it takes to become skilled in market research is overwhelming. But they know they need to invest their money to have a safe retirement plan.
You can be sure that your long-term investments will pay you off. You can rely on the compound interest for long term investments.
If you are still not sure about something, it’s wise that you consult with a financial advisor.
With over 20 years of experience in the financial industry, Robert Snow focuses on helping clients become financially proactive and achieve the best life possible with the money they have. While also offering them safe and effective ways to grow their money.