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A Guide to Diversifying Your Portfolio
Whether you’re saving up for your retirement or investing for other purposes, you have a wide range of assets to choose from. Most investors are familiar — at least to some degree — with stocks and bonds, and they may also have heard about the importance of diversifying their investment portfolio.
With the many investment options out there, investing may seem overwhelming because how do you choose what to invest in? And what about the risk involved?
Because of such concerns, many people choose to simply leave their money in the bank. After all, it’s easier than investing it, and they avoid the perceived risk of investing.
But investing isn’t as complicated as you may think, and there’s a simple strategy you can use to optimize your portfolio and reduce risk: diversification.
Most investors have heard the advice to diversify at one time or another, but does it go beyond simply buying stocks in different sectors of the market? In this article, we will look closely at what it really means to diversify a portfolio and how you can set up an investment strategy capable of weathering nearly any market condition, financial hardship, or economic turn.
What is a diversified investment?
Diversification is the investment strategy of investing in a blend of unrelated asset classes with the goal of reducing risk and maximizing returns. It is not putting “all your eggs in one basket,” and it’s one of the most fundamental and effective risk management techniques out there, which is why any financial advisor or fund manager will sing its praises.
A basic example would include splitting your portfolio up between sectors such as technology, consumer goods, healthcare, finance, and energy. But how can you take it to the next level? You could further split your portfolio up between stocks, ETFs, and options. This might seem like a solid diversified strategy, but if you look again, you’ll notice that all of these segments still hold one thing in common: They are all paper assets, which are digitally traded, and are ultimately tied to the economic conditions of the stock market, the dollar, and the strength of the US economy.
Is it possible to hedge your investments even further, completely outside of the stock market? This is where physical assets with true value come into play — the two most solid ones being land and precious metals.
Why should I diversify my investments?
Diversification reduces risk and protects your wealth
The main purpose of diversifying your financial portfolio is to decrease your risk exposure and minimize volatility and downside movements. If you invest in only one asset class — stocks, for instance — you risk losing your entire investment when the stock market crashes. And that could happen even if you diversify among several stocks since they would all be affected negatively by a crash.
However, if you invest in a mix of assets, you spread your risk. The key here is to invest in assets that are uncorrelated — for instance, when stocks go down, gold typically goes up. Thereby, the losses from one asset class are being mitigated by the increased yield from another asset class.
With a properly diversified portfolio, you can effectively protect your wealth from market volatility, sector crashes, the weakening dollar, inflation, political uncertainty, and geopolitical tension.
A diversified portfolio maximizes yields and exposes you to more growth opportunities
On average, a truly diversified portfolio yields higher returns long-term compared to a portfolio invested in a single asset class. For instance, in the chart below, you can see how a portfolio diversified with gold more than doubled the performance of a portfolio invested only in stocks.
A diversified portfolio doesn’t guarantee gains, but it typically improves returns and historically performs better than non-diversified portfolios. Speaking of returns, when you allocate your funds to different asset classes, you also benefit from gains in each asset class.
Diversifying your portfolio gives peace of mind
All financial markets have some degree of uncertainty; as an investor, you can never know when the stock market crashes, when bonds tumble, or when commodities decrease in value. However, with a truly diversified portfolio, you can have peace of mind that you have hedged your retirement savings against any market volatility. So, the next time there’s talk about a looming stock market collapse, you know that you won’t lose all your hard-earned money or — even better — that your wealth can grow if you have the correct mix of assets.
How do I diversify my portfolio?
Determine your investment goals
Before you decide the composition of your portfolio, you need to determine your
- investment time frame (in the case of retirement savings, when do you plan to retire?),
- financial needs (how much money do you estimate you’ll need during retirement?), and
- risk profile (are you comfortable with high risk? Note: Typically when saving for your retirement, you’ll adjust your risk profile along the way as you may want to be more aggressive in the beginning but more careful as you approach retirement age)
Finding and understanding the answers to these questions will help you determine the optimal mix of assets and adjust your portfolio regularly to take into consideration new market developments and changing needs.
Build a well-rounded portfolio
Diversification isn’t only about owning as many different assets and asset classes as possible. It’s about owning the right mix of assets. You don’t need to own 100 different stocks, bonds, and other assets. The trick is to own investments that play different roles in your portfolio.
Think about building your portfolio like building a sports team: You need a well-rounded team where each member plays a different role for the good of the whole team.
So, one of the basic rules of diversification is that each investment should serve a different function. How your team is put together depends on your financial goals, your risk appetite, and your investment horizon.
Stay diversified within each asset class
In addition to spreading your wealth among several asset classes, you will also want to diversify within each asset class. Again, the choice of assets will depend on your specific situation; below are some examples of different types of asset classes to help you diversify.
For stocks, you may want to have an S&P 500 index fund that exposes you to large-cap stocks and another index fund for exposure to small-cap stocks. It might also be advantageous to include both domestic and international companies. Additionally, you should consider investing across several different industries. For example, you wouldn’t want to put your entire life savings into the US tech industry because if the tech giants fall, so would your entire savings. Likewise, a mix of growth, dividend, and value stocks could work well for you.
In terms of bonds, your optimal portfolio could include both short- and long-term bonds; corporate bonds and Treasuries, and US and international bonds. You may also want to look at bonds with different duration (a measure of its sensitivity to changes in interest rates).
Adding alternative assets, such as real estate and physical precious metals, is a great option too. Gold and silver, for instance, historically perform very well when typical investments such as stocks and bonds crash, and — most importantly — they are the best-known inflation hedge out there. When adding physical precious metals to your portfolio, a mix of gold and silver — and perhaps even platinum — may be the best option.
What should I do once my portfolio is set up?
Once you’ve built your portfolio, it’s time to celebrate! You’ve taken an important step towards securing your wealth and your retirement. Over the next many years, you can enjoy the peace of mind of knowing that you’re taking great care of your finances.
There’s still some work to be done, however. As technology advances, markets fluctuate, and economic conditions change, you need to revisit your portfolio to make sure it’s still the optimal mix of assets and asset allocations. Your own situation might also change — perhaps you got an unexpected promotion or want to retire earlier. Inevitably, you’ll need to rebalance your portfolio to meet those change needs and conditions.
Ensure that you keep track of your portfolio’s performance. Does it meet the benchmarks you and your advisor set? Should you increase or decrease your stock holdings? Should you add more or different precious metals?
As part of your regular portfolio maintenance, you should do the following:
- Monitor your investments periodically for performance and risk.
- Rebalance your portfolio to adjust your asset mix with your financial goals in mind to adapt to changes in the market and economy.
- Review your investment plan annually to ensure your goals still make sense to your current and expected situation.
If you are unsure about the specifics involved in a certain asset class, you always have the option to partner with an advisor in that space who can act as your subject matter expert to fill in the gaps of your knowledge and allow you to make objectively informed decisions.
Working with Gold Alliance, for instance, you’ll have 24/7 online access to view the performance of your precious metals investments, and you’ll receive regular statements. In addition, your dedicated Sr. Portfolio Manager is always just a phone call or an email away if you have any questions.
Physical precious metals offer true diversification
Only a few assets offer true diversification. These include physical gold and silver. Precious metals have a 5,000-year history of protecting and growing wealth during times of financial uncertainty, economic collapse, and wars.
Your financial advisor might not recommend investing in physical precious metals. They might not even mention physical metals as an option. But that’s not because they don’t think gold and silver are great investments. The reason is much simpler than that: Financial advisors don’t recommend physical metals because they simply don’t offer them as part of their services, they don’t earn commission on metals, or they simply don’t know about the many benefits of precious metals. One thing they do always recommend, however, is diversification — and unless you have invested in precious metals already, physical gold and silver are undisputedly a diversified addition to your portfolio.
With over 18 years of experience, a solid reputation, and excellent customer service, Gold Alliance is an industry leader and has one of the highest ratings on the Better Business Bureau. We hope that you consider us when you consider diversifying your investments because why wouldn’t you consult a company with experience when you make decisions about your financial future?