What is Diversification and Why It Matters

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Investing is a key component to your retirement plan. Many people are confused and overwhelmed by the investing: how it works and the ways to do it effectively.

One of the most important pieces of investing is diversification. Now, you may have heard that term thrown around in financial articles, in meetings, and in the media, without these outlets explaining what it is and why it could benefit you. 

My team and I would like to rectify that! This post will delve into the meaning of diversification and the many ways it can impact your investing strategy. Let’s jump in. 

What Is Diversification?

Diversification is seen in an investment portfolio whose assets provide the highest return for minimum risk. An investor would diversify their portfolio in order to reduce the risk of their investments by placing their assets in classes, sectors, industries, and regions of the world. This range in investments often comes in the form of stocks, bonds, certificates, mutual funds and commodities.

Why does it make sense to invest in seemingly unrelated industries and products? By expanding the scope of your investments, your individual investments won’t rely on any others in your portfolio to do well: they each react differently to the market. When your assets aren’t dependent on each other for success (or conversely, failure) you are decreasing the risk of your overall portfolio which can help you with long-term financial success. 

The goal of diversification is to stabilize your investments while still getting a high return. In essence, diversification is the fancy term for the common idiom don’t put all of your eggs in one basket. This is an important strategy to apply to your retirement savings. 

What Does A Diverse Portfolio Look Like?

We talked a little bit about what particular assets you may want to consider for a diversified portfolio. I’d like to expand on those options below. 

  • Stocks
    • It is a good idea to hold both U.S and International stocks. Vary the size of the companies (small, mid-range, large) and industries (technology, health, information, transportation, etc.) you invest in and keep an eye out for emerging markets as these can bring you a higher return.
  • Fixed income
    • Bonds (Treasury, saving, corporate, municipal), are a great addition to your portfolio. Often times they are safe and low-risk investments that can withstand many market shifts. 
    • Other forms of fixed income include a certificate of deposit (CD) or savings accounts.
  • Commodities
    • Oil, gold, sugar, coffee, etc. The price will vary based on supply and demand over time and don’t adhere to the market in the same way that stocks and bonds do. 
  • Real Estate
    • This could be the equity in your own home, investment property, a real estate mutual fund or a real estate investment trust (REIT). 

There are many ways that you can diversify your portfolio. You can use the process of asset allocation to help determine the amount you should hold in each category. The most important thing is that your investment strategy is in line with your risk tolerance and your financial goals. Your financial advisor will be able to help you strike the right balance.

Why Does Diversification Matter?

Market risk is a reality that all investors have to face. The stock market is alive, volatile and, most importantly, subject to change. You won’t be able to time market shifts, but you can put your investments in the best place for success, and diversification aims to do that. 

Let’s say, for instance, that you own a lot of stock in a technology stock. The company may look healthy now, but technology changes quickly. These changes might hurt your investment a lot. Balance is an important piece of your financial puzzle and diversification of your assets brings balance and cohesion to your investment profile. 

Investing is all about the balance of risk and return. It is important to know that there will be both throughout time. By being intentional with your investments and safeguarding your portfolio, you will be able to more effectively manage it while staying on track to achieve your long-term goals. 

We know that diversifying your portfolio is a tall order. Managing the nuances of an investment portfolio can be a lot of work and confusing if you are doing it alone. Here at Retire To, we love empowering our clients with the knowledge and confidence they need in their investing practices. It is our joy to help people stay in line with their values and reach their goals. 

Are you ready to re-think your investment strategy? Give us a call today. We can’t wait to hear from you. 

 

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