Investing pros have their eggs in many baskets. Warren Buffett keeps Berkshire Hathaway well-diversified, and Jim Kramer moves money between an enormous number of stocks. Diversification is the mantra of many investment advisors for good reason. Equity and even bond markets are unpredictable, even for the pros. No one has a crystal ball, so while it may be easy for TV pundits to explain why the market did what it did, if you watch the financial news, you know how much harder it is to predict what the market will do.
How to diversify
With a sound investment strategy, the normal volatility of the markets shouldn't cause you to lose any sleep. Diversification is the bedrock of any strategy worth its salt. To get the most out of your investments, Investopedia recommends the following steps to achieve the diversification that minimizes risk while optimizing return.
1.Spread risk in equities
Equities offer a great return over time, but the downturns can be terrible. Hedge your bets by buying stocks in multiple sectors. Often, stocks in one sector go up and down together; however, you also need a diversity of companies within that sector. Bad news related to one company might come out unexpectedly. Also, diversification increases your chances of riding high on one company's unexpected good news.
2.Bonds provide stability
Even if you are a young risk taker, some of your portfolio should consist of bonds. When equities fall, bonds often rise, providing a cushion when stock market sell offs strike. Bond funds make sense for most investors. These funds give you exposure to many bonds, so they are very safe. By allocating 10 to 40 percent (depending on age and risk tolerance) of your portfolio to bonds, you can create a diversified portfolio.
Disciplined contributions on a weekly, monthly, or quarterly basis help diversify. As you add new money, you rebalance your portfolio to keep the desired ratio between bonds and equities and between sectors and individual stocks.
4.Get out when the time comes
Even the most diversified portfolio suffers when severe corrections strike. Keeping up to date with market news is essential. When things change, it's time to rebalance your investments. If things look scary, rebalance your portfolio to the conservative side. If a sector or company is vulnerable, don't be afraid to take your profits or a loss and put that money into a better bet.
Diversification goes beyond stocks and bonds
Once you have a handle on diversifying stocks and bonds, it's important to realize that true diversification needs to go beyond these investment tools. Though a well-balanced portfolio of 70 percent equities and 30 percent bonds may serve well for the money invested in the stocks-and-bonds universe, it is important to have money invested in other places as well.
Every well-diversified portfolio contains cash. The first rule of cash savings is to always have enough to cover emergencies, such as car repairs. This prevents you from charging on credit cards or being forced to raid your investment portfolio at a bad time. If you have enough for emergencies, then it's a matter of how aggressive you want to be. Even aggressive investors should have some cash on hand for new investment opportunities, while more conservative investors may want to keep a share of money in cash equivalents, like CDs. When dealing with important documents and data, it is crucial to keep it protected and secure. Consider researching “how to password protect a folder” in order to learn how to keep those important portfolios secure.
Cash is safe except for the effects of inflation. Stocks and bonds hedge against the inflation risk of cash, but you may also want to consider hedging against a fall in the dollar itself. Gold provides a hedge, as well as foreign currency. Most investors have no desire to take delivery of bullion or trade currency like George Soros. If stocking gold and foreign notes isn't for you, no problem. There are many well-managed gold and currency funds to choose from. By buying into some of these, you can hedge your portfolio against the dollar's decline.
You already may be exposed to real estate through your home; however, buying into a real estate fund can give you broader exposure, including to commercial and international real estate.
Foreign stocks are a good idea as a hedge against shocks to the U.S. economy. Unless you are in the investment business, buying individual foreign stocks can be very risky and time consuming. For most, investing in a foreign stock fund works best. Let the pros worry about what's happening in markets on the other side of an ocean.
The best option to diversify retirement savings
Many people are unaware of the benefits of a self directed IRA. These accounts offer more than tax savings. They allow you to invest in a multitude of instruments. Self-directed IRA investors can put money into stocks, bonds, cash equivalents, real estate, precious metals, energy, secured and unsecured notes, and hedge funds. They even allow you to become a venture capitalist and invest in startups. For investors willing to put some effort into their retirement savings, a self-directed IRA offers unbeatable diversification and profit opportunities.