Diversification is a common investment strategy among financial planners and individual investors. The main goal of diversification is to mix and blend different investments into your portfolio. Holding different types of investments helps to minimize the risk of losing capital due to market volatility. It also allows the investor to be invested across various market segments, which may lead to capturing gains if that sector or industry does well.
Tips for Diversifying Your Investment Portfolio
Disciplined investing should eventually become a habit and rule you make for yourself. Being disciplined will help you make tougher decisions when the market is more volatile than normal. Usually by the time an investor can react to a certain market change, 80% of that change has already occurred (Palmer, 2021). This leaves very little room to react to these changes and come out in the green. With disciplined investing you can focus more on creating a strong portfolio and sticking to a strategy, rather than haphazardly trading without any overarching philosophy.
Limiting short term transactions will help with taxes as well. Short term transactions are ones in which you bought and sold the same investment within 12 months. Short term capital gains are subject to higher taxes than long term gains.
Spread Your Wealth
Spreading your wealth is a basic way you can diversify. It’s the age-old adage of “not putting all your eggs in one basket”. Having a diversified portfolio means you’re spreading your portfolio across different asset types, companies, industries, and geographic regions.
Equities, bonds, and real estate are examples of ways to diversify and ultimately limit your risk. What’s more, within each of the above categories there are subsections where you can further diversify your portfolio. For example, subsections of equities include: U.S. stocks vs international stocks, large company stocks vs medium or small stocks, or growth-oriented vs value-oriented, among others.
An equity is money that is invested in a company by buying shares of a company in the stock market. Equities can be for U.S. based companies, or for companies located overseas. With that being said international stocks have different risks that U.S. stocks may not necessarily have. Some of these include currency fluctuation, political instability, varying taxation rates and different regulatory laws. While international stock have different variables than domestic stocks they should not be viewed as innately more risky.
The subsectors large cap, mid cap, and small cap refers to the market capitalization value of a company. Market capitalization is the stock price per share multiplied by the number of outstanding shares in circulation. Large cap companies have a market capitalization of $10 billion or more. Mid cap companies have a market cap from $2 and $10 billion. Small cap companies have a market cap of $300 million to 2 billion.
A bond represents a loan for the borrower from an investor. Bonds are also known as fixed income instruments. The bond includes details of the loan and its payments. These details include the end date when the principle of the loan is due to be paid back. It also includes the terms for either a fixed or variable payment for the borrower. Bonds have a rating system that helps show the creditworthiness of that entity. These ratings are on a letter based grading scale from “AAA” being the strongest and “D” being the weakest.
There are plenty of ways to invest in real estate. Generally speaking, REIT investments (Real Estate Investment Trust) are the least labor-intensive because you can buy and sell them like stocks. REITs are similar to mutual funds, in that the management company pools investors’ capital together to purchase, operate and/or sell real estate properties. The income or gains from real estate activity is then distributed back to investors through dividends.
Consider Various Investment Types
There are approximately 3,500 publicly traded companies (“stocks”) in the U.S., and even more overseas. While it is possible to create a diversified portfolio by purchasing individual stocks one-by-one, there are also other options available to investors who don’t have the expertise or time to research individual companies.
ETF’s or “Exchange-Traded-Funds” are funds that target various sectors, industries, or regions. ETFs can be useful if you are just starting to build your investment portfolio and are looking to diversify at a low cost.
Mutual funds are another way to diversify your portfolio. Most mutual funds are “actively” managed, which means there is a professional money manager deciding how to invest the fund’s assets. There are many advantages and disadvantages for both ETF’s and mutual funds that should be known before investing in them.
Continue to Build Your Portfolio
Adding to your investment portfolio at a set increment can be an easy and efficient way to help grow your portfolios over time. Dollar-cost-averaging (“DCA”) is an example of investing at set increments. DCA is when you have a sum of money that you periodically invest on a set time schedule.
For example, saving part of your paychecks into a 401(k) or transferring $100 per month every month into an IRA. Dollar-cost-averaging ignores stock or share prices, as it focuses instead on investing at set intervals regardless of what is going on in the stock market.
Similar to dollar-cost-averaging, setting realistic goals when investing can help you stay grounded even in market volatility. The average stock market return over the past century is about 10% per year. Knowing this, you should set your goals accordingly and not expect to become rich over a few months or even years. Growth of your portfolio will take time, patience, and dedication. Be disciplined in your strategy, continue to grow your knowledge as well as your assets, and always remember to diversify.
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The S&P 500 is a market capitalization weighted index of 500 leading U.S. companies and one of the most common benchmarks for the broader U.S. equity markets.
The NASDAQ Composite Index measures all NASDAQ domestic and international based common type stocks listed on The Nasdaq Stock Market. Launched in 1971, the NASDAQ Composite Index is a broad based Index. Today, the Index includes over 3,000 securities, more than most other stock market indices. The NASDAQ Composite is calculated under a market capitalization weighted methodology index. To be eligible for inclusion in the Composite the security’s U.S. listing must be exclusively on the Nasdaq Stock Market (unless the security was dually listed on another U.S. market prior to January 1, 2004 and has continuously maintained such listing), and have a security type of either: American Depositary Receipts (ADRs); Common Stock; Limited Partnership Interests; Ordinary Shares; Real Estate Investment Trusts (REITs); Shares of Beneficial Interest (SBIs); Tracking Stocks Security types not included in the Index are closed-end funds, convertible debentures, exchange traded funds, preferred stocks, rights, warrants, units and other derivative securities.
If at any time a component security no longer meets the above eligibility criteria, the security is removed from the Composite Index.
The Stoxx Europe 600 is a subset of the STOXX Global 1800 Index. With a fixed number of 600 components, the STOXX Europe 600 Index represents large, mid and small capitalization companies across 17 countries of the European region: Austria, Belgium, Czech Republic, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.
The Shanghai Composite Index is a market capitalization weighted index made up of all the A-share and B-shares that trade on the Shanghai Stock Exchange.
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