In building an investment portfolio you will need to take several things into consideration. One of these is that investments involve trade offs. There is always a risk that comes with investing our money. One way to mitigate that risk is by diversification. Diversification is the practice of distributing the risk involved in investing across different types of investments, including across different types of asset classes, products, geographical locations, and times. This helps increase the odds of investment success throughout the volatility of the markets. Diversifying your investments allows you to have investments that react differently to similar market or economic events. In this way, diversification helps you get the most out of your investments by reducing the amount of risk that you are exposed to in any one type of class of investment. In essence you should never “put all of your eggs in one basket.”
A few ways to diversify your portfolio include:
Asset Class Diversification
Asset class diversification, or asset allocation, refers to the spreading of the portfolio funds among different asset classes. Participating in asset allocation means having a mix of assets within your portfolio, having a mix will assist in lowering your overall risk exposure more so than would than owning only stocks, bonds, or another single category of assets.
Index funds, annuities, mutual funds, life insurance, and exchange trade funds
, are just a few products that are available to investors. When you peel back the fancy wrappers of these products, they are all basically a combination of cash, bonds, and stocks. All of these products have their place in most individuals’ portfolios, and very few investors should ever rely on a single asset product. Other asset products include , tangible assets, such as real estate, precious metals, and other commodities, which can contribute to the overall portfolio diversification.
Global diversification often helps in lowering the risk in your portfolio by increasing your exposure to the global markets. By doing this, you allow your portfolio to take advantage of
the different countries’ economies, which often concentrate in different market sectors than those domestically. Globalization and inter-connectivity are here to stay and are going to increase. The United States only represents five percent of the world’s population, and, despite having being the world’s largest national economy, it still only accounts for twenty percent of the world’s total income according to the United States Trade Representative. Owning stock and bonds from companies outside of the United States will allow you to have a broader diversification should the United States have an economical slow down while other areas of the world thrive.
Look at time diversification as dollar cost averaging. The strategy behind dollar cost averaging consists in making regular contributions of a set dollar amount towards the same fund or stock over a long period of time regardless of the market conditions. When dollar cost averaging is used over long periods of time, it tends to reduce investment risk, reducing average costs per share over time and allowing the investor to purchase more shares in an economic downturn.
Most financial professionals will agree that
, although having a diversified portfolio will not mitigate all risk of loss, diversification is the most important part of producing long-term financial gains while minimizing the risk to your portfolio.
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