8 Helpful Tips for Diversifying Your Investment Portfolio
Smart, regular and disciplined investing from an early age is the best way to ensure you have a sizable investment for when you retire or when you decide to exit your investment positions. The key to the best investment return is diversification. A diversified stock portfolio can withstand market forces and protect your investment from volatility. Diversification helps minimise risk and allows for a certain level of investment since it offsets possible risks in the market. Every investor has different goals and objectives and this is why there is no one way to diversify your investment portfolio. There are some general rules that apply, though, and we are going to look at some helpful tips that can help you diversify your portfolio.
What Is Diversification, and Why Is it Important?
Diversification is an investment strategy that blends various investments into one portfolio. The thinking behind diversification is that investing in different types of investments can lead to higher yields. However, the main reason why diversification is so important is that it protects you from shocks that can exist in a single market or investment class. For example, if you hold both stocks and commodities like gold, market shocks that affect stocks might not affect commodities and so your investment is protected.
When thinking about diversification, investors will often think about more than asset classes. They will often consider different industries, tenures, and investment plans in addition to the investment classes. When thinking about industries, investors who want to invest in medical stocks would be advised not to invest in pharmaceuticals only, but to also think about biomedical and biotech companies. All of these investment opportunities may be in the same industry but they are all very different.
Spread Your Money
Expanding from above, investors have to think about investing in more than one stock or sector. Stocks of valuable companies are great to invest in, but investors are advised to create their own mutual funds or to invest in several companies they know, are interested in or interact with every day. Creating a personal mutual fund means allocating small percentages of the money you have to invest to several stocks instead of lumping it into one stock.
Besides stocks and mutual funds, investors should also think about investing in exchange-traded funds, commodities, real estate, real estate investment trust, bonds and others.
Many investors are biased towards investing in domestic securities. However, international exposure is an important part of diversifying your portfolio. Focusing on domestic investments could mean missing out on opportunities that exist in markets that are growing. This is especially important for investors who focus on the United States and China, where looking beyond investment opportunities in these countries when they stagnate could be key.
Even though many people look at the United States, Asia and Europe as the main investment markets, many other markets are maturing or have matured enough to be considered as part of investors’ international diversification plans.
Know How to Allocate Your Assets
Even when you know that you need to spread your money and look outside your domestic markets for investment opportunities, how do you invest when you find suitable investment opportunities? Generally, there are high-risk investment options with higher returns like stocks and investments that are more stable and that have slightly lower risks such as bonds. To minimise your risk while also ensuring you get the best return, you need to divide your money and invest in both categories. The trick is knowing how to divide your money and invest in such as to minimise risks and increase returns.
Asset allocation is usually determined by age and lifestyle. If you are younger, you can invest in riskier options, choosing stocks and investments that offer a higher return. A general rule for asset allocation is subtracting your age from 100. The remainder is the percentage of your investment that you should hold in stocks. This means that if you are younger, you can hold a higher percentage of stocks while those who are older should have a higher percentage allocated to bonds.
If you are older, also consider dividend stocks instead of investing in common stocks. Much like bonds, dividend bonds pay out a certain amount depending on the period specified on the agreement when you invested. Many of them pay a percentage of the share price (known as the dividend yield) every three months. Investors can find stocks that pay high dividends through WealthSimple, whose aim is to make investing, growing your money and building wealth simple. They combine powerful technology and human help to help investors get the most out of their investments. WealthSimple manages over $10 billion in client assets in addition to having financial advisors to help investors build their portfolios.
When allocating your funds, it is also important to consider your lifestyle. If you cater for large family expenses, you should be more cautious about investing large sums. Because you might have limited funds, it is important to be more cautious about the amounts you are investing and where you are investing them.
Use Qualitative Risk Analysis
Although it is impossible to eliminate the inherent risk that comes with investing, it is possible to minimise this risk. To reduce the unpredictability of your stock investments, apply qualitative risk analysis before you buy or sell a stock. To do this, you need to apply a score to each parameter of a stock to see how successful it will be.
Some of the parameters you need to consider include the company’s business model, its brand value, profitability, management, dependability and sustainability of its products and services, its competitive advantage and corporate governance. The better a company does in each of these segments, the better its stocks will be to include in your portfolio.
Consider Money Market Securities
Money market securities include securities that allow you to deposit or invest an amount of money for a fixed period and be paid a periodic interest or a lump sum interest at maturity. Some of these most common money market investments instruments include certificates of deposit, treasury bills and commercial papers.
In addition to their lucrative payouts, money market securities are easy to liquidate, but you might incur some penalties when you do so too early. Among all these money market instruments, treasury bills are arguably the best investment option to go with. This is because they are backed by the central government and so their returns are all but assured. The only downside is that their returns are usually not as high as the return of the other money market instruments. They do make up for this by having very low risk. They are great for both medium and long-term investment.
Money market securities are great for parking your money in low-risk investments as well as offsetting the risk of other investments in your portfolio.
Invest in a Mix of Mutual Funds and Exchange-traded Funds
It is perfectly okay to create your mutual fund as discussed above. The only downside is that you may not be able to tailor the stocks included within the mutual fund to your investment goals, and you also do not get professional help when you do so. Many mutual funds and ETFs are managed, meaning a financial expert will get in touch with you to find out what your goals are, how much you have to invest and other details. Once they get everything they can, they will build a diversified mutual or exchange-traded fund for you.
They may also suggest mutual funds and ETFs that would be a great fit for you without having to build one from scratch. In these cases, ensure the fund you end up with has at least five different asset classes and that you do not invest more than 25% of the money you have in any one fund. Also, remember to diversify your fund investments globally, across industries and capitalisation sizes.
If you would like to go further, you can check the stocks and investment options inside each of these funds. You can find all of this information online or from the investment group that holds the mutual fund or ETF.
Rebalance Your Portfolio
Balance is very important in investing. Rebalancing means checking your portfolio periodically to see if their investments are meeting their target allocations. Rebalancing is also used to ensure the portfolio maintains a healthy asset mix.
When rebalancing your portfolio, you need to take a look at all your investments and balance the portfolio across all assets. For example, if you have a mutual fund that holds tech stocks and have invested in individual tech stocks, you might want to get rid of the individual tech stocks to reduce exposure in the tech sector.
Portfolio diversification is an important strategy that all investors should know about. It allows you to minimise your risk and exposure while also ensuring you get the most out of your investments. When done right, diversification allows your money to do the most for you so you can achieve your investment goals.
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