When times are uncertain, it can be reassuring to have a solid, well-thought-out investment strategy designed to serve you well for the long haul, no matter what’s happening in the world or the markets. One of your first steps in developing such a strategy may be to consider a wide variety of investments. This technique is called diversification. You may have heard the phrase, “Don’t put all your eggs in one basket.” That’s what we’re talking about here. While it won’t guarantee a gain or protection against a loss, diversifying your investments may help you increase your potential for success over time. Here’s why…
No asset type is always on top
Over time, investments that might be considered top performers can move around dramatically in terms of their returns. That’s because different types of assets react differently to the same market or economic events or conditions. As a very general and broad example, if the economy is growing, stocks may perform well, but when the economy slows down, bonds may do better.
Minimize the risk of loss
One of the benefits of diversifying your portfolio is that you can help mitigate the risk of a bad loss in any one sector or asset class. If nearly all your money is in one type of investment, your entire portfolio might take a big hit if that investment performs poorly. However, if your money is spread out among a variety of types of investments, that one investment won’t necessarily drag down your entire portfolio. The other investments might perform well, potentially offsetting losses in the poorly performing investment because, with diversification, different asset classes in your portfolio move differently when faced with the same market conditions.
Increase your opportunities for gains
With diversification, you can have an opportunity to capture gains. With your money in more investments, your chances of one or more of them performing well increases. If you’re only invested in one type, however, you’d have to count on that one investment performing well.
Smooth out the volatility in your portfolio
With a diversified portfolio, you may also experience a smoother ride when it comes to performance. Instead of big ups and downs, you could potentially experience more consistent, level overall portfolio performance, which may help give you the discipline to remain invested in the long run.
Is your portfolio diversified?
Just because you have a lot of investments, doesn’t mean you’re diversified. Take a look at each investment’s returns. If they move together (up together, down together), they’re probably not diversified enough. Two mutual funds with different names can actually contain the same or similar underlying investments — which can mean that they’re not diversified with respect to one another. A financial professional can help you look at the underlying investments, based on your particular needs, goals, risk tolerance and circumstances to help you make sure they are truly diversified.
Over time, your investment mix will change
As your needs change or as you get closer to retirement, you may want to revisit your diversified portfolio and potentially make changes to better reflect your risk tolerance, retirement time horizon and goals. Consider contacting your financial professional each year to review your portfolio and how your investments are diversified.