Everyone knows, as the saying goes, that you should never keep all your eggs in one basket – this is especially the case when it comes to investing. As any advisor will tell you, diversification is not necessarily about increasing your wealth – it is instead about protecting it. If you diversify effectively, one portion of your portfolio might be in decline but gains in other portions will balance it off.
That said, how do you actually go about diversifying in a way that protects your hard-earned wealth while still giving you a reasonable return?
Before you Diversify
Diversification is not something that you should do on a whim or without careful thought and research. Be sure not to fall into a false sense of security by thinking that your wealth is protected once you have diversified your portfolio. Your choice of investments should take into account your time-frame, your comfort with risk and volatility and of course your financial needs. The more risk you are willing to take, the higher the potential returns – or losses. This underscores the importance of having relatively safe investments as a part of your holdings.
You should also commit to reviewing your portfolio on a regular basis in order to make sure that it is still diversified to maximum effect. You may need to rebalance your holdings if you have too much or too little of an asset after a period of time.
Remember that diversifying isn’t just about having many different assets, it is about having many different kinds of assets, and diversity within those asset categories. You need to make sure that you aren’t investing in assets with a significant amount of overlap, or you will end up de-diversifying your holdings!
Different Kinds of Assets
There are a number of different kinds of assets that should be considered as part of a diversified portfolio. Stocks can help you grow your wealth while bonds can generate income. Cash gives a degree of stability to your holdings, while real estate typically holds its value against inflation. Some are riskier than others – the key to a well-diversified portfolio is to have some relatively low-risk assets to balance off more volatile holdings and help you maintain the wealth you are working to build. How much of your portfolio should be “safe” will depend on how you evaluate your risk profile.
Here are some of the safest options out there to think about when you are diversifying:
Bank Accounts – it doesn’t always occur to people that just keeping their money in the bank is an investment option. You do get only a very small return – but your money is protected. Most banks offer different kinds of account, some of which come with higher interest rates. Look for savings accounts or money market accounts. Pay attention to inflation rates if you choose this option as you may end up losing money in the long run.
Certificates of Deposit (CDs) – these are basically loans that you make to the bank for a fixed period of time in exchange for a guaranteed return once the CD matures. The longer you are prepared to lock in your money, the higher the rate of return you will receive. Look into creating a CD “ladder” by combining longer and short fixed terms. If you renew them as they mature, you have a casade of CDs which can be renewed at higher interest rates.
Treasury Securities – there are 3 different kinds, Treasury Bills, Treasury Notes, and Treasury Bonds. They are similar in principle to CDs in that your money is basically loaned to the government for fixed periods of time. The difference is that you buy these securities at the going rate and cash them in for face value when they mature. The longer you are prepared to lock in your money, the higher a return you will receive.
Money Market Funds – these are mutual funds that invest only in short-term safe assets like those in this list. You can buy and sell them at any time, and they are considered to be quite safe. There are risks and interests are not fixed which makes returns difficult to predict.
These options will not make you wealthy, but they are an important way to balance risk in well-diversified portfolio.