Below are some top tips to help when diversifying your portfolio.
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It is not just bonded versus stocks.
When people hear about a diversified investment portfolio, they start thinking about a combination of bonds and stocks. For many years, financial advisors have been emphasizing the ratio of stocks to bonds when investing and diversifying in order to minimize risk. This isn’t the only way of looking at diversification.
With time, your portfolio is going to outsize exposure to given asset classes or specific sectors within the economy. People who owned a diversified portfolio of tech stocks back in the late 90s were not diversified because the businesses they had stocks in were tied to the same factors and trends. The NASDAQ Composite index was down about 80% from its peak in March 2000 to its low in 2002. The NASDAQ Composite index is used for tracking tech stocks.
This makes it important to consider the sectors and industries that you are investing in. Is diversification dead? Not at all. If you notice that an area is carrying an outsized weighting, then trim it back so you can maintain your diversification.
Using index funds for boosting diversification
You can use index funds to build a diversified portfolio without having to spend much. Buying EFTs or mutual funds that are tracking broad indexes like the S&P 500 is easy and it doesn’t cost a lot. This is an easier approach because you can build your portfolio and monitor the companies to which your investments are exposed.
If you want to take a more hands-on approach, index funds will help add exposure to specific sectors and industries that you might be underweight. Such funds tend to be more expensive compared to those tracking the most popular indexes, but if you are interested in a more active approach when it comes to your portfolio, then it is a good way of adding exposure to certain industries.
Don’t forget about cash
This is one of the most overlooked parts when building a portfolio, but there are some benefits. There is almost a guarantee that cash is going to lose value because of inflation, but it can provide you some protection when there is a market selloff. Depending on how much cash you have in your portfolio, it can help your portfolio decline less compared to market averages when the market is facing a downturn.
Cash is also good because it gives you optionality. The value is not going to come from the cash, but rather from the options you have when the future environmental changes. Most people focus more on the investment opportunities in the present and ignore the future. When you have cash in your portfolio, you can easily take advantage of any investment opportunities that come your way when the marketing is going down.
Target-date funds make things easier
Investing in target-date mutual funds is a good way to maintain a diversified portfolio. The funds will let you pick a future date as your investment goal, which for most people is their retirement. When you are far from the date, the fund is going to invest in riskier investments like stocks, but it shifts allocation towards safer assets like cash and bonds as you get closer to your goal date. You most likely want to know how the fund invests your money, but they are best when you want a “set it and forget it” approach.
Periodic rebalancing keeps on you on track
With time, the size of your holding changes based on the performance of your portfolio. Holdings that have a strong performance are going to account for more in your total portfolio while the low performers will decline. If you want to maintain your diversification, then it is important to rebalance your portfolio from time to time and ensure each investment has an appropriate weight. You can do this quarterly and you need to check on such things at least twice a year.
Thinking global with your investments
There are many investment options in the U.S., which makes it easy for most to forget about other countries. There are great investment opportunities in the global economy. You have a lot of opportunities outside the borders that can give you a good return. If you have focused too much on the U.S markets when investing, it is time to start researching emerging markets. There are a lot of options in Europe and other emerging markets. Countries such as China are seeing a faster long-term rate compared to the U.S. which can be a good thing for your investment.
Investing in the global markets can also help on protecting your investments from negative events that exclusively affect the U.S. market. When the U.S. is seeing an economic slowdown, not all countries are going to feel it. The reverse can also happen. There are challenges that come with emerging markets given their underdeveloped economies and financial markets. There might be some bumps in the process. The goal of diversification is to smooth out the bumps no matter where they are coming from.