Everybody knows the adage “Don’t put all your eggs in one basket.” Indeed, diversifying your investment portfolio is key to reaching your financial goals.
Diversification refers to spreading your investments among asset classes, industries, and styles in order to reduce the risk that negative events affect all your portfolio at once.
1. It’s a way to protect against losses.
As is commonly stated, “don’t put all your eggs in one basket,” this piece of advice applies equally well when investing. While every successful venture does exist, many unsuccessful investments have experienced losses or gone bankrupt as well. Diversifying can help mitigate against such losses by creating a balanced portfolio composed of stocks, bonds and cash to reduce market fluctuations for you personally.
Diversifying requires including investments with differing degrees of correlation and expected returns, like mutual funds or exchange-traded funds (ETFs), that meet these criteria. Mutual funds and ETFs often hold such assets – including stocks, bonds and other financial products that fit this mold – but for true diversification to take place it requires deliberate management by an experienced fiduciary advisor who can work closely with you to develop a strategy tailored specifically to your financial goals, risk tolerance and timeframe.
2. It’s a way to increase your risk-adjusted returns.
Diversification can increase returns by expanding the possibilities of what your portfolio can accomplish. Diversification also reduces the risk that you won’t meet future financial goals, but must be implemented correctly – for instance if you buy multiple stocks from just one industry (say railroad or airline stocks), only when those industries improve will you reap its benefits; it is wiser to diversify by purchasing technology or media companies and emerging market investments that often offer greater growth potential.
Remind yourself that every wildly successful investment also involves losses, so by diversifying your investments you can better weather any bumps on the way and remain focused on reaching your goals.
3. It’s a way to take advantage of growth opportunities.
Diversification allows you to take advantage of market trends and opportunities across asset classes, sectors and geographic regions. Furthermore, it helps reduce exposure to single investments that might not pan out.
Investors who heavily invested in tech stocks during the tech boom of the late 1990s were hit hard when these investments lost value during a market downturn, such as healthcare or consumer goods. Diversification would have protected these investors by shifting investments toward assets with better performance during such downturns such as healthcare or consumer goods.
Diversifying your portfolio, no matter if you are an experienced investor or just getting started, can give you peace of mind. While diversification does not eliminate risk entirely, it can reduce losses while positioning you to take advantage of growth opportunities as your investments expand. Working with a financial adviser is one option for identifying optimal allocations; alternatively robo-advisors provide convenient assistance by building tailored portfolios tailored specifically to your goals, preferences and risk tolerance.
4. It’s a way to reduce volatility.
Diversification will not ensure gains or protect against losses; however, it can lessen their impact by decreasing overall volatility in your portfolio. This can be achieved by selecting investments with differing movements – like stocks, bonds or cash – so as not all your assets move in the same way or degree.
Diversifying by industry or sector is another great way to reduce risk. If your portfolio only contains technology stocks and that industry experiences an unexpected setback, its entire value could take a dive. By diversifying into healthcare, energy, and finance industries as well, however, you can lower potential losses while positioning it to take advantage of future growth opportunities.
Diversifying away all risks is impossible, but by understanding its advantages and working with an experienced fiduciary advisor you can still achieve your financial goals while mitigating risk.
