Diversifying your investments - it's a phrase you've heard, and you know you should do it, but what does it actually mean? Essentially, it means that putting all of your financial eggs in one basket is a bad idea. The market is notoriously unpredictable, and diversification will play a vital role in fortifying your interests. You can reduce your investment risk, stabilize your income flow, and have a better shot at long-term financial success by investing in a wide variety of different assets that are in line with your goals and risk tolerance.
How a Diverse Portfolio Can Provide Long-Term Financial Stability
Why is it Important to Diversify?
In any business or investment, there's always an element of uncertainty. There are times you smile your way to the bank and times you curse your poor decisions. Diversifying your portfolio offers some protection by reducing the impact of significant losses in certain areas of the economy. It does so by ensuring your portfolio includes assets that aren't interconnected. As a result, your portfolio is on considerably safer ground, as it's highly unlikely that a single event will have the same impact across diverse businesses. Dissimilar assets generally react differently to shake-ups in the market and provide the best defense against a potential financial crisis.
What Can Happen if You Don’t Diversify?
Don't even consider it! Not diversifying your portfolio can be a recipe for disaster. Without a diverse portfolio, a significant financial crisis in one area of the economy could considerably harm or even wipe out your entire portfolio. There's also the potential disadvantage of your business not growing as fast as your competitive counterparts. Have you been wondering how your competitors are growing so quickly while you're left in the dust? It could be because they are seeing great returns on a smartly diversified portfolio and are using that to invest back into their business.
How do you Diversify your Portfolio?
Before diversifying your portfolio among bonds, stocks, and other investments, there are a few things you'll have to consider. Factors like your age, risk tolerance, financial goals, and family needs can affect the way you choose to diversify your money. It's always best to consult a financial advisor if you're ever unsure on the best way to proceed! But just to give you an overview, here are some common ways to diversify:
Diversify Across Asset Classes
Asset classes are different types of investments that carry different levels of risks. They include stocks, bonds, and cash. If you want an asset that offers the highest potential for growth, then stocks are what you need. Stocks generally do well when the economy is on the upswing. However, they also carry the most risk. If you aren't big on taking high risks, you likely want to have a low balance of stocks in your portfolio and make sure to invest in shares of many different companies in diverse fields of business.
Bonds, on the other hand, offer a modest return in the market but are not volatile, so you can be more comfortable counting on their return. For example, the StreetShares bond product, Veteran Business Bonds, offers a fixed 5 percent interest rate. If you were to invest in the stock market, you may see a rate of return higher than 5 percent- but, you also may lose everything. If that isn't a roll of the dice you're willing to do with your money, then a more bond-heavy portfolio may be your best bet (although it is important to note that bonds also carry risks and you may lose investments in any market). There are also cash investment opportunities, which have an even smaller amount of risk than bonds. However, this again means lesser returns.
The advantage of these three asset classes is that they're independent of each other and in most cases they tend to perform differently under the same market conditions. Diversifying across all three asset classes virtually assures there will be no simultaneously significant losses occurring across your entire portfolio, helping you to balance your investments. As an investor, you get to choose the percentage of capital you want to invest in each asset class. The percentage you pick can be based on asset class risk tolerance, years to retirement, and many other factors. For example, you may choose to invest 60 percent in stocks, 30 percent in bonds, and 10 percent in cash if you have a high-risk appetite and are looking for higher potential returns.
Diversify Within Asset Classes
To further minimize your risk, it's also wise to diversify within the asset classes. For example: in bonds, you can diversify by risk. There's a difference in the maturity of various bond holdings, where some holdings get to mature faster than others. There are similar factors that you can use to diversify your holdings within the stocks and cash markets.
While diversification is not a guarantee against a loss, it's a key component to assist you in attaining your long-term financial goals while also minimizing your risk. Also keep in mind that diversifying your portfolio is not something you do only once- it should be a habit. If you need help coming up with a well-diversified portfolio, it's always advisable to seek the guidance of a financial advisor.
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