The Importance of Portfolio Diversification
The best strategy for long-term investment growth is to have a diverse portfolio of financial instruments. Spread your risk across many investments to be financially savvy.
We’ve all heard the saying, “Don’t put all your eggs in one basket.” Nowhere is this more true than in financial investing. If you invest in only high-risk stocks and the market plummets, you’re left with nothing. On the other hand, if you invest in slow-moving mutual funds, you won’t see much return on investment in the short-term.
The best strategy is to invest in a balance between short-term and long-term investments, otherwise termed portfolio diversification. With a diverse portfolio, your financial instruments will have different risk and return profiles. Keep in mind that the best investment strategy is long-term; it may seem like a good idea to invest in high-risk, high return, short-term stocks, but the risk involved is often overwhelming. You are likely investing to grow a strong retirement fund (you don’t want to work forever!), so building a solid, balanced risk portfolio can help you increase equity over 10-50 years.
Tip 1: Invest in Different Industries
Moreover, do not invest in a single type of instrument (stock, bond, mutual fund, T-Bill, insurance, real estate). Limiting yourself to a single industry and/or investment instrument limits your ability to ride the ebb and flow of the global economy. Consider investing in oil, consumer products and orange juice for a bit of kick to your portfolio. That way, if something negative happens to a single area (a freeze kills all the orange trees) your investments won’t be so negatively affected as a whole. Remember, too, that you should invest in areas where you feel somewhat confident in your related knowledge. If you don’t know that orange groves can be devastated by the winter frost, orange futures might not be the best fit for your portfolio.
Tip 2: Add to the Pot
Investments are ongoing, decadal projects, so continue to put money into your portfolio on a regular basis. Additional funds allow you additional freedom to invest in areas that you want to explore. If your company offers a 401k matching plan, max it out to get the most contributory benefit.
Pay attention to the overall increase in gains to your “basket” of investments in your portfolio. A volatile stock may lose money, but if you balance it with mutual funds or bonds, you may still come out ahead. Get a nice mix of different levels of risks.
Tip 3: Work with a Pro
Think about working with a financial advisor, at least to start your portfolio properly. A professional can give you information about a company or investment that you might not know otherwise, and can make recommendations based on when you want to retire (or otherwise use your money). What she would suggest for retiring in five years might be more risk-heavy than the mix she would recommend for retirement in 30 years.
With a financial advisor comes a fee, usually based on the dollar amount of your investment and returns. Fees will vary based on the firm, but can average ~1% of assets under management. Always ask up front when interviewing investment firms.
Tip 4: Pay Attention
You don’t have to check the stock ticker daily, but continue to stay connected to your portfolio and its related industries. Read articles about the companies and sectors that relate to your portfolio. Look for trends that might inform future investments.