The word “diversification” is often tossed around when discussing financial planning, but not everyone understands its importance for an investor’s success. Diversification protects investors from catastrophic losses in uncertain times and ensures stability for their families and future.
The word “diversification” is often tossed around when discussing financial planning, but not everyone understands its importance for an investor’s success. Diversification protects investors from catastrophic losses in uncertain times and ensures stability for their families and future.
After the past two years of our country battling COVID-19, both medically and economically, we can all understand the value of stability in uncertain times. But, by not “putting all your eggs in one basket,” you avoid subjecting yourself to the volatility of a few securities and the changing marketplace. So, if you are ready to start building out a diversified portfolio, here’s what you need to know:
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What Is Diversification?
Diversification is “a risk management strategy that mixes a wide variety of investments within a portfolio.” Aiming for a healthy variety can strengthen the value of your investments.
So, how does diversification strengthen an investor’s portfolio? Diversification aims to limit exposure to risk for the individual investor by spreading investments out across multiple industries, locations, and types of securities.
Diversification also protects investors.
How Does Diversification Protect Investors?
In a diversified portfolio, it is expected that some securities will perform better than others. However, when one or some of the assets take a turn, the portfolio is still strong because others will continue to grow. While this does not guarantee capital preservation, it can help your portfolio see consistent growth rather than volatile ups and downs.
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What Does An Ideal Diversified Portfolio Look Like?
So, for a far more practical response, what does a diversified portfolio look like? Studies show that the ideal number of securities for a diversified portfolio is between 25 to 30 on average. However, the portfolio cannot be diversified enough to protect against risk and create the maximum potential for rewards with too few securities. Based on your plan set by you and your financial advisor, the right mix provides the optimal balance between security and growth.
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Ways to Diversify Your Portfolio
Diversification is a complex process in which your financial advisor needs to be involved. There are many ways to diversify, including the following:
- Industry: Some economic and natural events will affect select sectors more than others, which is why it can be dangerous to invest in one industry too heavily.
- Investment type: Some types of investments provide greater security in the long run than others. For example, bonds are typically considered to be lower-risk than stocks, and real estate investments can offer lifestyle and financial benefits.
- Location: Adding international companies to your portfolio can grant you access to industries and assets not available within the U.S. While it can complicate the process, it is well worth the effort to allocate a portion of investment capital into the international markets.
- Company size: Startups have infinite growth potential, but realizing that possibility is unlikely (9 out of 10 startups will fail within the first few years of development). The payoff for those who succeed is enormous; therefore, it may be worth considering an investment in smaller companies as they’re starting out. However, you need to bolster startup investments with diversification among larger and well-established brands that are nearly guaranteed to help you earn.
- Management: Different management styles can help some companies weather the storms better than others. For example, companies that were able to adapt to remote working management quickly could financially recover from COVID-19 faster than those that couldn’t. It’s not just about the money, but the people within an organization that can make it strong.
If you’re ready to start building out a diversified and robust portfolio, our team would love to talk to you! We help individual investors find companies that are good for people, the planet, and their portfolios. Schedule a consultation with us here.
1 Source: Investopedia