Understanding portfolio diversification is the first step to creating a more mature, well-rounded portfolio. Regardless of your age or how long you’ve been investing, diversification is an essential part of every financial plan.
The future is uncertain, and that’s why having multiple income streams towards different goals can be beneficial over time. Even if one area experiences short-term problems, then another area still might help you make up for it in the long run. If things like rising interest rates possibly hurt dividend-paying stocks (which pay out cash every quarter), then maybe REITs would make up for it because they tend to rise with interest rates (higher price = higher yield).
Here are eight tips to help you better understand portfolio diversification:
1. Don’t Put All Your Eggs in One Basket
This is the most basic rule of investing, and it still applies today. You never want to have all of your money invested in just one security or asset class. This leaves you open to many risks if that particular investment falls in value.
2. Diversify by Asset Class
There are different types of assets that you can invest in stocks, bonds, commodities, and Real Estate; consider checking out options like DST properties for sale. It would help to spread your money out among these different asset classes. This will help reduce your overall risk if one particular type of investment falls in price.
3. Diversify by Company Size
It would help if you also diversify your investments by company size. Investing in small-cap companies comes with more risk than investing in larger companies. It’s not to say that some people couldn’t have success owning just small-cap companies, but this is usually for the professional investor, not someone with little experience.
4. Diversify by Industry or Sector
You can also diversify by industry or sector. For example, you could own both financial and healthcare stocks rather than only one of those types of securities. The financial services sector tends to do better when interest rates rise, and healthcare does better when they fall (based on their margins). So this would be an effective way to hedge your portfolio against certain macroeconomic events.
5. Don’t Forget about Geographical Diversification
Try not to ignore geographical diversification either. Owning companies in the same geographical region can expose your portfolio to certain risks that you might not be able to diversify away. For example, if most of your investments are in the U.S., then you’re more exposed to economic problems here than if some of your money was invested overseas.
6. Diversification is a Balancing Act
Every investor has different goals and risk tolerances when it comes to diversification. This means that there isn’t one specific plan for everyone – all investors have their unique situation, which requires their unique strategy. The more time you spend developing an understanding of financial markets, the better you will get at deciding what asset mixes work best for your specific.
7. Know How Much Risk You Can Handle
Before making investment decisions, you have to know how much risk you can handle. If your goals are long-term, then it’s probably not a good idea to take many risks with your investments. However, if you’re investing money that needs to be used soon or for a shorter-term goal, then taking some more risks might be necessary.
8. Diversification isn’t Just About Buying Different Securities
Another great way to diversity is by using options strategies. For example, selling put options can generate cash flow and reduce the cost basis on stock positions in your portfolio. This strategy works well when you own highly volatile stocks, which tend to make big price moves in both directions (long puts would help limit downside while selling calls could help generate income).
Also, keep in mind that diversification doesn’t mean buying different securities. You could also achieve diversification by investing in a mutual fund or ETF. These types of investments offer instant diversification across many companies, sectors, and asset classes.
When it comes to your investment portfolio, it’s always important to remember the adage: don’t put all your eggs in one basket. This is especially true for something as important as your retirement savings. Diversification is one of the most important concepts in investing, and it’s something that all investors should be familiar with.
In conclusion, there are a few different ways to diversify your investments. You can diversify by asset class, company size, industry, and sector. You can also diversify by geographical region, and you should know how much risk you’re comfortable taking on. Finally, remember that diversification doesn’t just mean buying different securities – you can also achieve it through options strategies or investing in mutual funds or ETFs.