How to Diversify Your Financial Portfolio
Part of that basic knowledge lies in understanding what it means to have a diversified portfolio. Although some pros may argue with you, most agree that it is important to diversify your investments.
So what does that mean? Read on to find out more, along with some tips on how to diversify a portfolio.
What does it mean to diversify your portfolio?
Let's start at the beginning. Your portfolio is the collection of financial assets that you're using in the hopes of earning more money. It can include stocks, bonds, cash, gold, bonds, cryptocurrency, and many other specialized types of investments. So, what is portfolio diversity? It means you have more than one investment, whether it's multiple stocks or a variety of investments.
The importance of portfolio diversification
A diversified stock portfolio will include stocks from various companies, preferably in different sectors — say, a few stocks in healthcare, a few in technology, and maybe some in agriculture. The idea isn't to collect stocks like baseball cards, but to stretch your investments across various types of businesses.
Why? Well, let's say you have all your assets invested in agriculture. Then, due to climate change, big-ag has a few bad years, where earnings aren't what they should be. You could lose out. But if only 10% of your portfolio is invested in agriculture, the losses there could be mitigated by gains in another sector performing better.
In other words, a diversified stock portfolio is the living embodiment of the adage to avoid putting your eggs into one basket. If your eggs are in one spot, a single fall could smash everything. But if your eggs — or your stocks — are in different areas, the blow will be much softer, and you'll still have the opportunity for gains.
How should I diversify my portfolio?
There are as many ideas on diversifying your portfolio as there are traders on the stock market floor. For beginning investors, one option is to purchase an index fund. These vehicles can be mutual funds or exchange-traded funds (ETFs) that follow a benchmark index — the Standard & Poors 500 Index is the most common. This diversified stock portfolio allows you to invest in several stocks that traditionally perform well, at a reasonably low cost, because there's no active trading being done.
Index funds use a passive investment strategy, which may mean that you don't earn quite as much, but you're buffered from the spikes or troughs of individual stocks.
What does a diversified portfolio contain?
It's worth considering that the best way to diversify a portfolio may involve far more than stocks. Stocks generally form the basis of a diversified portfolio, but there's no need to stop there. Bonds, commodities, real estate investment trusts (REITs), and more, can be added to your portfolio to leverage the different risk levels of these investments.
The more diverse your portfolio, the more protected you are from market volatilities. One caveat for the small-scale investor: avoid assets that come with high administrative costs, as this can eat away at your profits.
Risk vs. stability
When you're considering the best way to diversify a portfolio, it's important to also remember that increased risk may lead to increased financial rewards — but it also leaves you open to higher possible losses. Traditionally, a stock-based portfolio will outperform one invested in bonds.
In its best year, according to Vanguard's portfolio allocation models, a portfolio that's 100% invested in stocks earned 54.2%, while bonds earned 45.5% in their best year. But when you're considering the worst possible scenarios, stocks slip by -43.1% while bonds only drop 8.1%. So, based on historical models, you have the option to both gain more and, possibly, lose more with stocks than with more stable bonds.
Diversified portfolio life insurance
When considering how to diversify your portfolio, think about placing some of your assets in a life insurance policy. Life insurance rates for some types of permanent policies, such as indexed universal life insurance, fluctuate with the economy. However, other types (such as term) don't, making them a stable monthly expense that brings peace of mind while protecting your family, your mortgage, and more.
Ready to start diversifying your portfolio by adding a life insurance policy to the mix? Apply today.
The information and content provided herein is for informational purposes only, and it is not to be considered legal, tax, investment, or financial advice, recommendation, or endorsement. You should consult with an attorney or other professional to determine what may be best for your individual needs.