Why It’s Smart to Diversify Your Portfolio
Diversification is a way of spreading out your investments across various types of assets.
By diversifying their portfolios, investors are able to reduce their overall risk, while increasing the return on their investments. Wouldn’t you like to learn more about the best ways to diversify your portfolio for higher investment earnings?
A major key to success in investing is balancing your risk level with your desired timeframe. This is why it’s important to ensure you are carrying just the right amount of risk versus reward. For example, You’re in your early 20’s and just starting a retirement account. In this situation, you wouldn’t want to be too conservative with your investments. If you are too conservative, then you may discover the growth of your investment is not keeping up with the rate of inflation. On another example, you’re reaching retirement age and add risky investments to your portfolio. This would not be good at that time of your life to start taking high-risk investments. You shouldn’t leave yourself open to the volatility of the market.
Therefore, to balance your risk and reward appropriately, it’s a smart idea to diversify your portfolio. By doing so, you can help eliminate both risk and volatility in your portfolio. Additionally, you can reduce the amount of stress you incur watching the numbers. Just remember, diversifying doesn’t guarantee you a larger profit or that there will be no losses.
The Different Types of Investment Risks
When making an investment, investors are faced with two primary types of risk:
- Undiversifiable: This type of risk is commonly referred to as “systematic risk.” It will be found with every company investors look to invest in. Since this risk is not specific to any industry, there is no way to get rid of or lessen it through diversification. To put it simply, it’s just a risk that must be accepted by investors. Some examples of Undiversifiable risk include inflation, war, interest rates, exchange rates and other factors out of investor’s and/or the company’s control.
- Diversifiable: This type of risk is commonly referred to as “unsystematic risk.” It is specific to an entity, such as a company, country or industry. Due to this being a risk that is specific to an entity, investors can lower their risk through diversification. Therefore, the goal here is to invest in multiple assets that are not all affected the same way by market changes.
Why You Should Diversify Your Portfolio
Ensuring your financial portfolio is diversified to protect you against market changes, is key to successful investing. Take a quick look at our example to see why it’s a good idea to ensure diversification within your portfolio.
Let’s say your portfolio only had stocks from a coal company. If the government decided to start offering tax breaks to households using 100% renewable energy, your financial portfolio would likely take a hit. This is due to the coal company losing business as more households switch to renewable energy for the tax breaks.
However, if you had diversified your portfolio with both the coal company and renewable energy company, only a portion of your portfolio would have taken a hit during the market change. And, your stocks in renewable energy would have likely seen an increase. Thus, balancing out your loss with the coal company.
On the other hand, you could diversify even more. You would want to do this as both coal and renewable energy have a close relationship. This means they may face a downturn at the same time. Therefore, when practicing diversification, it’s important to not only choose a variety of companies but a variety of industries and asset classes.
Diversify your Portfolio with These Components
With a number of companies to invest in, your options as an investor truly are limitless when it comes where to invest your money. However, there are a number of components that make for a well-rounded financial portfolio, which include the following:
- Stocks: One of the most common investment options. Generally, stocks are more aggressive than most investments. And, they provide investors with a high growth opportunity over the long term. But, this also means a greater risk is being taken, especially when looking at the short term.
- Bonds: With bonds, there’s generally regular interest paid out to the investor. In addition to this, bonds are typically seen as a less risky investment. Many use bonds to balance out their stocks. This is due to stock and bonds not having a close relationship in the marketplace. Therefore, when the stock market tanks, bonds remain intact. While investors in bonds generally have to accept lower returns, they can find peace of mind knowing their returns will not waver as much as the stock market.
- Asset Allocation Funds: This type of investment is most commonly seen at your larger financial advisor offices. These include companies such as Edward Jones or Fidelity. Most often, investors with no time or the knowledge to build up a diverse portfolio, utilize asset allocation as a “single-fund” strategy. In this, investors allow a financial advisor to make decisions for them. These decisions are based on the financial goals discussed with the advisor.
- Real Estate: There are a number of ways to invest in real estate. Some of these include a traditional real estate fund or real estate investment trusts (REITs). Additionally, investors can choose to invest in crowdfunding real estate platforms. When investors diversify your portfolio into real estate, they are able to further protect their portfolio against any market changes. Plus, through crowdfunding real estate, investors can easily invest in a number of properties. This aids in lessening the risk of their investments even more.
The Goal of a Diversification Strategy
When are trying to diversify your portfolio, there are a number of factors you must take into account. First, remember that diversification is not about maximizing returns. It is about limiting the impact the market has on your portfolio. This is why it’s key to take your time and come up with the best possible diversification strategy. One must also remember that over time, your strategy will change as your risk tolerance and time horizon begin to change.
For example, let’s say you started investing when you were in your early 20’s. At that time, you likely had a high-risk tolerance and over twenty years to build your portfolio up. Therefore, you were likely invested in some riskier stocks with a larger potential for growth. However, if you are nearing retirement age, you may consider moving some of the riskier investments into ones with less risk. This is due to needing the money in a shorter timeframe. Thus, you don’t want to risk everything you have when you need to cash out soon for retirement.
Diversifying with Real Estate
Real estate is a great way to diversify your financial portfolio and recently has become available to the average investor. Not long ago, only the uber-rich or individuals with the “right” connections could invest in private real estate deals. However, that’s simply not the case anymore.
With the passing of the Jumpstart Our Business Startups Act in 2008, crowdfunding real estate platforms are now available. Even more so, they are allowing investors to easily start investing in real estate with low minimums. Simply browse the pre-vetted investments available on the platform. Then, review the details and find one that fits your needs to start investing. It really is that simple.
At DiversyFund, our platform offers exclusive investment opportunities to investors. These are fully vetted and approved by our team that has more than two decades experience in real estate investments. By choosing to invest via a platform like ours, you are able to spread your investment dollars in a multitude of high-end income and growth offerings instead of just one. Thus, diversifying your real estate portfolio even more than was ever possible before. Check out our latest investment offerings here!