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Whether you are looking to make short-term or long-term investments, diversifying your portfolio may positively impact your level of risk. If you are new to investing, that may pose the question, what does diversifying your portfolio do?
What Does Diversification Mean?
According to FINRA, diversification is the “spreading of your investments both among and within different asset classes.” In simple terms, it means you aren’t putting all of your eggs in one basket. Meaning, you are investing in a variety of assets rather than just one. Overall, diversification along with some rebalancing, can help with risk management in the long run. Say some of your investments aren’t doing well. By having other positive securities, you can help balance the loss and even offer a higher return in some cases.
Diversifying your portfolio tends to start with asset allocation. Asset allocation is where you determine the percentage of your finances you are going to invest and where they will be invested. In this process, you can invest in a variety of asset classes like investment-grade bonds, high-yield bonds, domestic stocks, real estate stocks, etc.
Overall, bonds can be a less aggressive way to invest and diversify your portfolio. Investment-grade bonds tend to be safer and can offer less risk for your portfolio. Compared to investment-grade bonds, high-yield bonds can be more volatile, making them riskier.
Stocks are typically the most aggressive portion of your portfolio and can give you a higher return over a longer period of time compared to other types of investments. However, higher returns can also mean more risk, especially since stocks can be more volatile.
International stocks can offer you opportunities not included in US securities. This exposure can potentially bring you higher returns but at a greater risk.
Creating a diversified portfolio of securities, covering all of these asset classes can be stressful and time-consuming. However, that is why mutual funds may be a better option as they can provide access and diversification without the need for you to pick each security individually.
Ways to Diversify Your Portfolio
Now that you have a better understanding of what assets you may want to invest in, the next step is determining if you’d like to invest in these assets individually or find a fund that will invest into the various securities for you. Directly investing into individual securities like high-yield bonds and real estate funds can be a more precise way of building your portfolio. Indirect investing is where you find a fund made up of a variety of individual securities. A financial advisor can help you find a solution that will best fit your needs, but they may charge a fee for their services. They can provide you with different asset classes and funds to choose from while making your experience less stressful.
There are different types of fees financial advisors and sub-advisers can charge based on the type of services provided:
● Performance-Based Fees
● Fulcrum Fees (common with sub-advisers): determined by outperforming or underperforming a benchmark
● Flat Rates: set annual prices and flat percentage rates based on your assets under management
● Commission-Based Fees: percentage earned from sales and transactions
Where Does Rebalancing Come in?
As the performance of your portfolio changes over time, rebalancing can help with any declining assets you may have. These changes may also be known as market volatility, measured market price movements over a specific period of time.
Market volatility is commonly known to be negative as people assume this change means there is a drop in the market. However, these changes can also have a positive effect on investments.
For example, if your investments in high-yield bonds and real estate funds are overperforming while a couple of your emerging markets stocks are underperforming, you can rebalance your investments in a couple of ways:
1. You can move some of the money from your overperforming assets to the ones that may be lagging.
2. You can invest more money in the underperforming assets.
3. You can sell parts of the overperforming assets and use those funds towards a new investment.
In conclusion, diversifying your portfolio can be a smart investment strategy for both short-term and long-term investments. Financial advisors can help you build the right portfolio for you and can help you with rebalancing your assets annually so your investments are up to date. There may be fees or taxes involved when rebalancing your portfolio. Any questions you may have about diversifying your portfolio can be answered by your financial advisor or asset management company.
Sources:
https://www.finra.org/investors/investing/investing-basics/asset-allocation-diversification #:~:text=Diversification%20is%20the%20spreading%20of,strategies%20are%20all%20 about%20variety
https://www.dunham.com/FA/Blog/Posts/financial-essentials
Disclosure: This communication is general in nature and provided for educational and informational purposes only. It should not be considered or relied upon as legal, tax, or investment advice or an investment recommendation, or as a substitute for legal counsel. Any investment products or services named herein are for illustrative purposes only and should not be considered an offer to buy or sell, or an investment recommendation for, any specific security, strategy, or investment product or service. Always consult a qualified professional or your own independent financial professional for personalized advice or investment recommendations tailored to your specific goals, individual situation, and risk tolerance.
Information contained in the materials included is believed to be from reliable sources, but no representations or guarantees are made as to the accuracy or completeness of information.
Past performance may not be indicative of future results. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment.
Investors should carefully consider a fund’s investment goals, risks, sales charges and expenses before investing. The prospectus contains this and other information. Please read the prospectus carefully before investing or sending money.
Asset allocation, which is driven by complex mathematical models, should not be confused with the much simpler concept of diversification. Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns. Rebalancing may be a taxable event. Before taking any specific action, be sure to consult with your tax professional.
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