Whether you’re brand-new to investing or have been working to build your assets for decades, one of the most important strategies to employ is portfolio diversification. Diversifying your investment portfolio may sound complex, but it's a simple concept. The tricky part is determining how to apply it effectively in conjunction with your investment goals.
What is diversification?
Diversification is a strategy in which you spread your investments across different asset classes, industries, or even geographic regions to reduce risk. A more simplified diversification definition is “not putting all your eggs in one basket.” While the strategy does not assure a profit or shield you against market loss, it helps lessen the blow.
How to diversify portfolio investments
There are numerous ways you can diversify your portfolio, and it really boils down to what your goals are for your investments. For instance, you may want to take a more tax-advantaged approach to diversification. To keep things simple, we’ll use a traditional, well-rounded portfolio as an example:
- Stocks and Bonds: Start by investing in a combination of stocks and bonds. Stocks have the potential for higher returns but come with more risk, while bonds are generally more stable but subject to interest rate and credit risk.
- Different Sectors: Spread your investments across various sectors of the economy. For instance, consider technology, healthcare, and consumer goods. This way, if one sector is struggling, the others may help balance your returns.
- Geographical Diversification: Invest in both domestic and international markets. Global events can impact investments differently, so this can add varying degrees of volatility.
- Asset Classes: Explore alternative asset classes like real estate, precious metals, private equity, or even cash value life insurance, which can accumulate cash value in a safe and often guaranteed way. Cash value of a life insurance share some characteristics of bonds in your overall portfolio and can be accessed if you need it*. Alternative asset classes like these can perform differently in various economic conditions and can be a good way to invest beyond stocks, bonds, or cash.
- Mutual Funds and Exchange-Traded Funds (ETFs): These investment vehicles hold a mix of assets in one package, making it easy to diversify without buying individual stocks or bonds.
An important thing to remember is that your risk tolerance is crucial. If you're risk-averse, lean toward more conservative assets like bonds. If you're comfortable with more risk, you can allocate a larger portion to stocks.
An example of a diversified portfolio
Let’s say you have $10,000 to invest. Instead of putting it all into one stock, here’s what a diversified portfolio might include:
- a stock mutual fund
- a bond ETF
- an international stock ETF
- a real estate investment trust (REIT)
- a precious metals fund
This balanced approach spreads your risk across different asset types and can potentially lead to more stable and consistent returns. The allocation will depend on your risk tolerance, time horizon, objectives and other considerations unique to you.
Why is diversification important?
Diversification is important because, first and foremost, it helps reduce unnecessary risk. If you spread your investments across many different financial markets—rather than keeping your money in one place—your portfolio is less likely to suffer a catastrophic loss if there is a market downturn or if one sector or one stock takes an unexpected hit.
While risk reduction is the primary reason for keeping a well-diversified portfolio, other reasons include:
- More Stable Return Potential: Different asset classes perform differently in various economic conditions. Diversification can help stabilize your investment returns over time. It can also help you ride out market fluctuations, making your financial journey less volatile.
- Opportunity for Growth: While it mitigates risk, diversification still allows you to benefit from various assets’ growth potential.
A million and one things can go wrong with investments. It’s impossible to know the future, and we’ve all seen how unforeseen events can completely disrupt the economy—from the stock market to real estate to taxes and interest rates. Diversifying investments will help keep your portfolio from taking too sizable a hit if disruption and loss occur in one area, because you will also be invested elsewhere.
Your long-term investment strategy should be structured on the assumption that not all of your investments will pan out immediately, and a few may not pan out at all. So you’ll want to make up for any losses through other opportunities. Again, note that no strategy can assure a profit or protect against market loss.
Diversify your financial strategy
While investing in the stock market can be a principal component in helping you build your nest egg, you don’t want to rely solely on your investments for your future. For example, purchasing a life insurance policy that grows in cash value over time can help protect your family during the working years, and can provide access to cash value to supplement your retirement income when you no longer need life insurance.
Whether you need guidance with your investment decisions, you’re planning for retirement, or you want to learn more about life insurance solutions, it’s always a smart idea to connect with a financial services professional so you can talk through your goals. That way you can come up with a more well-rounded strategy that aligns with your unique situation and needs.
*Guarantees associated with a life insurance is based upon the claims paying ability of the issuer. Accessing cash value reduces death benefit and available cash surrender value.
Investments are offered by properly licensed registered representees of NYLIFE Securities LLC (Member FINRA/SIPC), a Licensed Insurance Agency and a New York Life Company
