How you feel about your investments is important to our comprehensive financial planning team. That’s what makes understanding diversification essential, as it is a serious investment strategy!
You don’t want to keep all of your financial eggs in one basket. This article will explain why and how in simple terms!
Let’s discuss how diversification can allow you to reach your long-term financial goals without being overexposed to risk.
What types of risks does diversification help reduce?
Market risks are commonly referred to as volatility. These possible losses are caused by factors that affect the market, like political conflict, war, pandemics, interest rate changes, and stock price movements. The only way to hedge these risks is by investing across various financial instruments.
Specific risks occur in a particular investment, company, or industry affecting the value of your associated assets. For example, if you only invested in tech stocks, and there was a shortage in raw silicon, this specific risk could affect your entire investment portfolio.
The importance of diversifying your investments.
The importance of investment diversification within your portfolio is to reduce risk—market risks and specific risks. This can help essentially help balance between loss and gain. In other words, if some assets don’t perform well, other areas of the portfolio in different sectors can make up for that loss.
Since DIY investors commonly start out by investing in one stock, let’s use that as a working example.
Imagine one basket as one stock. Putting all your money into one stock or even just a few companies can be a risky business. What if one of those companies goes under, or their performance plummets? Your investment will too—and it can happen quickly.
The success of your investment portfolio should not depend on a single stock, so reduce your risk by spreading your investments across different assets and asset classes. Why? Because they behave differently based on the market conditions.
To use another analogy, if one domino falls, the rest don’t tumble with it.
Why you should never put all your eggs in one basket.
The problem is that many investors put all their eggs in one basket, and only invest in one sector. This is risky since your nest egg could be wiped out overnight. However, if you invest in assets that don’t move in the same direction, pace, or time, you reduce your chances of losing all of your funds uniformly.
You can invest across asset classes and within asset classes in order to diversify your portfolio. For example, rather than investing in stocks alone, you may also invest in bonds, real estate, and more. This spreads your investments across asset classes.
If you buy stock from many companies of many different sizes and sectors, rather than just buying stock in a single company, you spread your investments within an asset class.
Discuss your current investment strategy with a Libertyville, IL, financial advisor at Prism Planning Partners.
Different types of investment vehicles to consider.
There are many investment vehicles to consider in today’s market. Some of the most common include:
- Exchange-Traded Funds (ETFs)
- Mutual Funds
- Certificates of Deposit (CDs)
- Money Market Accounts
- Real Estate
- Retirement Accounts
- Treasury Inflation-Protected Securities (TIPS)
Remember, some are more volatile than others and are more ideal for times of high inflation. As the market shifts due to global matters, it may help to rebalance your portfolio.
Historically, stocks have produced higher returns than cash or bonds, yet they come with higher risk since they are more volatile in nature. And while bonds have historically not produced the same high returns as stocks, they help to lower risk when the stock market is down.
How to choose the right investments for you.
The suitable diversification for your portfolio depends on your risk tolerance, time horizon, and financial goals. Your asset allocation should change with these aspects over time. Just as with global shifts that result in inflation, as you near retirement, your investments should shift to lower-risk investments.
Overall, you can follow these guidelines in getting started with choosing the right investments for you.
- Create a comprehensive financial plan.
- Evaluate your ability to handle risk.
- Think about an appropriate investment mix.
- Take caution in investing heavily in shares of your employer’s stock or an individual stock.
- Create an emergency fund to avoid tapping into retirement funds early.
- Pay off high-interest credit card debt starting with the highest first.
- Consider dollar cost averaging.
- Take advantage of “free money” from your employer like in 401(k) matching.
- Rebalance your portfolio as needed.
- Work with a fiduciary financial advisor who serves you above their own gain.
The benefits of diversifying your portfolio.
There’s a reason that the most wealthy investors and financial advisors around the world practice portfolio diversification. Overall, diversification:
- Reduces market volatility impact.
- Helps seek advantage of different investment instruments.
- Reduces the time to monitor your portfolio.
- Helps to achieve your long-term investment plans.
- Helps you take advantage of compounding of interest.
- Keep your capital safe.
- Lets you shift among investments
- Provides you peace of mind
How Prism Planning Partners can help with investment management.
By deeply understanding your goals and values, we can then design an investment portfolio that is right for you. At Prism, we ensure that your risk capacity aligns with your true emotions.
At Prism Planning Partners, we have years of study, experience, and consulting with industry experts. Our investment practice, as defined in this article, is to diversify your wealth among many different sectors—it’s essential for long-term portfolio success.
You can expect transparent and efficient portfolio design as well as tax management strategies, using techniques like loss harvesting, portfolio rebalancing, and low-turnover funds when appropriate. Our team looks forward to hearing about your financial situation and concerns and working with you for the rest of your lifetime.