You’ve likely heard the common wisdom about the importance of diversifying your investment portfolio, however you’re not at all uncommon in wondering what does that mean, exactly? And, how do I go about it?
In the broadest sense, diversifying your investment portfolio is akin to covering the spread in a bet or spreading your nest egg among many baskets. The idea is that you’re not leaving yourself vulnerable should any one investment not perform because you’ve covered your “bet” by spreading the risk among many investments in your portfolio.
A precise definition of portfolio diversification is offered by Folio Investing: Diversification is combining assets that don’t all move in the same direction, by the same amount, at the same time in reaction to market forces.
Investment portfolio diversification is a long-term strategy of built-in checks and balances. It is intended to minimise the risk of investing while maximising earnings over time. In short, the more diverse your investments or the more securities you own in different markets, the less risky your portfolio and the more earnings you’ll realise over time.
So how do you go about this diversification business? What is the prevailing wisdom about this strategy? The answer is actually up to you.
What’s Your Investment Style?
How do you consider yourself as an investor? Are you constantly online, checking out the latest financial news? If you’re heavily involved in your own portfolio strategy and management, then you may favour investigating the latest market trends (such as investing in real estate, housing, gold trading or foreign currencies) and diversifying your investment portfolio accordingly with these emerging options.
If you’re more laissez-faire and mostly concerned with simply developing a robust, diversified investment portfolio that will stand the test of time and vagaries of the market, then you’ll probably prefer a more traditional, diversified blend of stocks and bonds or you can opt for a managed mutual fund that contains a basket of stocks and / or bonds.
Words of Wisdom For The Take Charge Investor
Stay up to date: It is critical to keep current with fresh information about the market beyond the traditional stocks and bonds. Whether you do your own investing online or go through a financial advisor, the smart approach is to make your decisions with the most up-to-date information available from the most trusted sources.
For example, the most recent advice from established experts about diversifying your portfolio with investments beyond traditional stocks and bonds includes:
Housing & Real Estate: Yes, as counter-intuitive as this may sound, housing and real estate are investments recommended by a number of highly reputable experts.
For instance, Shawn Tully, the “Editor at Large” for Fortune, is most emphatic about investing in real estate now. Tully notes that after four years of plunging home prices the most promising “asset class” is housing.
Foreign Currencies: While no investment is without risk, the level of risk involved with investing in foreign currencies is relatively low, yet with the opportunity for extremely lucrative returns. What’s more, foreign currency markets are often unchanged by interest rate moves or stock market fluctuations allowing you to turn a profit in any economic climate.
Words of Wisdom For The More Traditional Investor
Keep it simple: If you’d rather not be checking into the latest numbers regarding the hottest investment trends daily, then the smarter option would be to stick with a more traditional (yet still robust) portfolio of diversified stocks and bonds.
This doesn’t mean that you’re not effectively managing your investments, however rather that you’re taking a less reactive and more remote, long-term approach to portfolio diversification. The clear advantage to this strategy is that you’re spared the constant monitoring of your holdings and their disparate performances (and a lot of premature grey hair).
Healthy Mix of Australian Stocks & Bonds: The key for diversifying your Australian portfolio is to include a wide range of stocks in both large and small companies, representing all industries. The same applies to bonds. Be sure to include a broad selection of both government and corporate bonds of varying maturities.
That said, it is still recommended that you move beyond strictly stocks and bonds and diversify your investment portfolio with:
Broad International Exposure: This doesn’t mean you abandon simplicity. Broadening your investment portfolio beyond Australian borders is advised so you are not beholden strictly to the Australian market. It is a good idea to mix in broad international exposure, including promising emerging markets.
Regardless of your style, portfolio diversification is a smart strategy for long-term investing. Smoothing out the peaks and valleys of the market by diversifying your investment portfolio, a well-planned investment portfolio that spreads investment risks with diversification is a sound approach to reaching your overall investment goals.