When it comes to advise on investment, professional managers will tell you to spread your funds around, or rather, diversify. And this is correct, in order to protect your assets, it is always best to diversify. The huge decline in stock prices over the past few years is enough evidence that putting all your eggs in one basket is a bad idea.
However, to diversify properly, it is important to know where to invest and how much money to put in a single investment. It also calls for knowledge on how to diversify within a certain investment category. This is what we are going to help you learn in this post.
Look For Variety and Not Quantity
Most people make the mistake of thinking that having numerous investments makes them diversified. However, to be properly diversified, you need to have a lot of varying investments. This means investing in bonds, stocks, cash, real estate funds and international securities.
Investing in each of these categories can do various things for you including:
1. Bonds help bring in income.
2. Your portfolio grows with stock investment
3. Cash lends you and your portfolio stability and security
4. Real estate offers a hedge against inflation plus low correlation to stocks. Simply put, it may rise when the stocks fall.
5. International securities offer a growth opportunity and help you maintain purchasing power.
Tips To Allocate Your Money
How do you know how much you should invest in each category?
Well, it is advisable to first put aside adequate money to handle short-term goals and emergencies. In order to learn more about saving for emergencies, you can read the post Emergency Funds: Creating Your Cash Reserve by Nolo.
Next, consider using the following tip: Minus your age from 100 and invest the remaining percentage in stocks and the rest in bonds. So, if you are 30 years old, you should put 70% in stocks and 30% of your assets in bonds.
Next, to diversify your money in other investments, you should adjust the percentages mentioned above using the following tip:
Invest from 10 to 20 percent of your stock portion in international securities. The younger you are, the higher the percentage. Remove 5% from the stocks category and 5% from bonds and then invest the 10% in real estate investment These are simply a hybrid form of investment that gives stock-like average returns, even though a huge portion of the returns is in dividends. Keep in mind that securities tend to be quite volatile, but they can help stabilize your returns, despite the huge difference in pace compared to other investments.
At the end of the day, you will have a pretty well-diversified portfolio in investments and emergency funds.
Diversify Within Investment Fields
After diversifying by putting your money into varying categories, the job does not stop there. For instance, it is not enough to purchase a single stock. You need to have various types of stocks in this part of your investment portfolio. This protects you from suffering when a single industry like health care or financial services goes down.
If you are not super wealthy, diversification by purchasing individual shares can be pretty expensive as you will be paying trading fees every time you purchase a different stock. A cost-effective way for a modest investor, most probably someone with less than $250K to invest would be to purchase mutual funds. These are investment pools that mix the funds of numerous investors in order to buy bonds, stocks, securities, real estate and much more. To make things pretty simple, you can purchase ‘index’ funds, which buy all shares of a certain index like the stock market’s S&Ps or Standard and Poor’s of huge company stocks. You also have the option of buying real estate index funds, international indexes, bond index funds as well as money market funds, which are basically your cash fund index.
If you want more information on diversification, then read this piece on investment portfolio diversification.
Balancing Risk & Returns
Even though diversifying is meant to protect you from huge losses, it ideally costs you in average yearly returns. That is because risk and returns go hand in hand in any financial market. Simply put, any investment that reduces your risk tends to reduce your returns.
So, do not hesitate to take a little risk, unless you are close to retirement, where that additional security is more important. Some investors argue that is being too conservative as it suggests that a 50 year old individual, who has probably 30 more years to invest should have a 50/50 stock and bond mix on their portfolio. These individuals say that is it best to minus your age from 110.
Well, the best answer is the one that is geared toward you. If the additional risk will not leave you stressed and always on the edge, then the latter can work for you. However, if it will keep you up at night, then consider sticking with the original investment plan, even if it does not seem to be that lucrative.