New investors are always encouraged to diversify their portfolios, but many are wary of heeding the advice. Some people think that spreading out their investments exposes them to more risk since a significant chunk of their finances is subjected to volatile markets.
But portfolio diversification is meant to protect you from risk. The goal is to invest in asset classes (e.g., bonds, stocks, etc.) that have low correlations with each other. This way, you don’t lose all your money when one asset moves down.
Follow these tips on strategic portfolio diversification to minimize your risks and maximize your returns.
1. Allocate your assets
Different asset classes have varying levels of potential risks and returns. Asset allocation means adjusting the percentage of each asset in your portfolio based according to your risk tolerance and investment goals.
For instance, if your goal is to grow your money and you have a high-risk appetite, you can decide to place as much as 80 percent in high-risk, high-reward stocks. The remaining 20 percent can go to money market instruments, which are among the most stable of asset classes and have low market risk.
If you’re unsure of how to effectively diversify our portfolio, there are asset allocation funds that already invest in a varied class of assets. These have a predetermined mix of investments designed to create an optimal portfolio that meets your risk tolerance.
2. Customize with individual stocks and bonds
You can customize your portfolio even further with individual stocks and bonds. The ratio of bonds to stocks to cash will depend on your objective, timeframe, and risk appetite. Again, put your money in funds that behave differently. Choose investment vehicles with varied risk profiles. This way, you can balance out your high-risk investments with low-risk ones that give you stable returns to protect your money.
Apart from choosing different asset classes, you should also diversify within the categories you chose. For stocks, invest in large, long-standing companies as well as promising startups from different industries. For bonds, choose a combination of government bonds and corporate bonds.
You can also diversify by investing in international stocks and bonds as more economies and markets mature around the globe.
3. Consider alternative investment vehicles
You can also look into alternative investment vehicles, which are private equities, funds, properties, and commodities that don’t fall into one of the conventional categories. Oil and gas investment companies, real estate investment trusts, and gold are some popular examples.
Because they’re unconventional, these alternative investment vehicles are ideal for diversifying your portfolio, since they have a low correlation with standard asset classes.
The hard assets, such as gold, oil, and real estate property also act as effective hedges against inflation. Inflation hedges maintain their value, and sometimes even appreciate, as time goes by, which protects you from the declining purchasing power of money. This means that if you decide to liquidate the asset, you won’t be selling them at a loss even as inflation rates increase.
4. Rebalance regularly
Diversification isn’t a one-time activity. Your portfolio requires regular rebalancing to retain the risk profile you want. The ideal period for rebalancing is every quarter, but twice a year should suffice.
Make necessary changes if the risk level of your portfolio isn’t aligned with your timeframe, financial goals, or investment strategy. Reallocate funds from investments that have outgrown their allocation to the underperforming ones.
Achieving your long-term financial goals requires balancing risks and rewards. Through diversifying, you’ll be able to choose the optimal mix of investments that can minimize your risk and maximize your returns. Consistently monitor your choices to make sure you’re still on track with your short- and long-term investment goals.