In my last article, I wrote about what portfolio diversification is and how it can add value to your investments. You can check it out here. Now, I want to focus more on what a diversified portfolio can look like. When looking to diversify your portfolio, you will want to invest in different asset classes. This does not need to be complicated; you don’t have to hand-select your own investments. There are options available to get a diversified portfolio.
Mutual funds
Mutual funds allow you to invest your money in a range of assets, such as stocks, bonds, gold, and sometimes cash. Different types of funds offer different diversification, depending on your risk tolerance. Equity funds are 100% stock investments and offer higher risk due to lower diversity. Balanced funds have a combination of stocks and bonds, providing steady moderate returns and moderate risks. Target-dated funds have a higher proportion of stocks that is reduced over time, thereby lowering your risk as you age. Although mutual funds are an easy way to diversify your portfolio without thinking, you can do more by selecting your own stocks.
Stocks
By adding stocks to your portfolio in addition to mutual funds, you can add further specific diversification to your portfolio. When you are beginning to pick individual stocks, you need to look at some key factors:
- Vary your selection by industry, which means that you won’t lose everything if one particular industry is affected by a market downturn. Recently with the pandemic, we have seen this downturn with the airline, hotel and cruise ship industries due to travel bans and general wariness to travel.
- Vary bases on company size. Don’t just invest in household names but also look at smaller companies. Although these smaller companies have a higher risk of failing, there is a large opportunity for growth. Don’t be too risky with them but having a few will help.
- Vary by country, as most investors in North America tend to stick to North American countries, forgetting about the Europe and Asia markets. The US stock market is maturing and might not have a lot of growth in comparison to the global market and growing economies.
Rebalance
It is not enough to just diversify your investments and leave them alone. Your portfolio should be checked regularly, annually or quarterly to rebalance and make adjustments. If one asset class is growing too fast and shifting your portfolio beyond proportion, move the asset to an under-performing sector. This might seem counterintuitive, taking money away from high-performing sectors, but the key to a diversified portfolio is keeping it diversified. If you become too concentrated in one asset class, you have an increased risk of loss. By keeping the asset classes in check, you keep your risks in check.
Diversification does not focus on quick returns over a short time period; it is about keeping your risk factors low so that you can rest easy at night. Depending on your age and your goals, the percentages per asset class will vary slightly. For example, a younger investor might be heavier in stocks, while a pre-retiree will be higher in bonds and gold, which tend to have less swing. When investing, there is a fear of losing money but with diversification, you can lower this risk and stay calm during market turmoil. Ensuring your portfolio is distributed across each asset class, industry, size, and country will help provide diversification to lower your risk tolerance. Keep it simple when starting out by investing in a few funds and stocks, don’t overburden yourself with too much to control on your own. If you are still unsure what to do seek help with a financial planner to build a portfolio that fits your needs.
