Investing in the right assets is one of the smartest ways to build wealth over the long term. Many financial planners, individual investors, institutional investors, and fund managers preach the gospel of diversification as an important tool for mitigating trading and investment losses.
Unfortunately, an explainer on Credit Loan reveals that a “large number of investors still don’t know how to diversify their portfolio correctly in order to avoid concentrating risk in any one market exposure.” This piece provides four insights into diversifying correctly as part of efforts to reduce the frequency or occurrence of some of the common mistakes that investors make.
- Spread Your Wealth
Diversification simply means not putting all of your investment eggs in one basket; hence, you need to spread out your investment across different asset classes. Ideally, you should have a mix of speculative and conservative investments. Stocks are a great wealth builder but you should not have all your investment as stock. Bonds are incredibly safe bets, but you shouldn’t hold all your wealth as bonds. You should also consider real estate, precious metals, commodities, and even cryptocurrency if you can stomach the risk.
- Diversify between stocks
You’ll ideally have a part of your investments held in equities: direct stocks, mutual funds or ETFs. Irrespective of your preferred level of exposure to equities, you should ensure that you are diversified across sectors and industries. Of course, you should try to limit your equities exposure to the stocks of companies that you know, companies that you use their products, and that you understand their business.
Nonetheless, you should avoid putting all your equities investments in tech stocks or biotech ETFs. You must diversify across different sectors of the economy and you should invest varying amounts of money in large caps, medium-caps, and small cap stocks found in the Russell 2000.
- Diversify between bonds
Most investors know the importance of bonds in their ability to provide stability to low-risk investors who don’t have the risk appetite for the rollercoaster ride of equities. Bonds are also wonderful assets that generate fixed income. However, you can still diversify across different kinds of bond investments. Mixing up your bonds exposure to index funds and fixed-income funds is a great way to ensure a mix that provides regular income without much volatility.
You may also want to diversify across federal, state, municipal and corporate bonds. Investing in foreign bonds can also be a great diversification tool if you can invest the required time for conducting due diligence.
- Rebalance to keep your portfolio dynamic
Smart investors understand the difference between investing and trading; hence, they use dollar-cost averaging to buy assets over time and they try to buy and hold for the long term irrespective of the short-term trends in the market. However, the fact that you have a perfectly diversified portfolio doesn’t mean that you can forget about your investments and expect your wealth to grow on autopilot.
You need to understand that the dynamics of the markets change regularly with the bulls and the bears controlling the market at different times. More so, your risk appetite is bound to change as different events happen in your life. A single unmarried investor will be able to take more investment risks than a married investor with kids. Hence, you need to check in on your investments regularly in order to ensure that you and your investments are synced with the prevailing market conditions.