More than 400 years after Miguel de Cervantes first warned us in his 1605 novel, Don Quixote, not to put all of our eggs in one basket, the message still rings true. As it pertains to investments, the key to success is often said in diversifying your portfolio. Diversification, however, is a two-fold process; when done correctly it can help you to reduce the risk of losses, while also maximizing your returns.
Diversifying Two Ways
Within Asset Classes
Ask anyone with a healthy portfolio what their investments are in and you might be surprised to hear “a little bit of everything.” Contrary to popular belief, successful investors rarely invest in one industry exclusively. The rationale supporting this is that your stocks should vary across multiple industries to prevent being impacted by one singular event.
As a general rule, investments across various sectors perform better or worse at different times. Factors that could impact their success include market conditions, interest rates and/ or current global events.
For example, if you were to invest solely in the pharmaceutical sector but then the FDA made a widespread announcement regarding drug manufacturers, the likelihood of all of your investments taking a hit would be increased. If you invested in pharma companies, software and airlines for example, the two latter industries would not be affected by the FDA announcement, and in turn, your investments would be protected.
Between Asset Classes
It’s not enough to diversify simply across multiple interests or industries, however. You should consider diversifying between asset classes—which is to say, stocks, cash, real estate, and bonds amongst other options. Allocating your assets in this way protects your portfolio from losing value across the board in the event of a failing investment.
Diversifying With the Help of Mutual Funds
Investment programs, such as mutual funds, are natural first steps for individual investors. With a mutual fund, your investment is spread across multiple groups of stocks, immediately delivering you a diversified portfolio. As an added benefit, mutual funds are managed by professional stock managers that have assessed any reasonable risks for you. This helps to alleviate the stress of deciding which stocks to invest in yourself.
The Bottom Line
If you’re just getting started with investments, it’s important to remember that there are no “safe bets”—but there are smart decisions. Choosing to start sooner rather than later is always recommended to ensure your investments have time to mature, weather any market volatility, and ultimately, generate consistent returns on a long-term basis.
From 401K planning to asset management and college planning to retirement, don’t wait until it’s too late to plan a future for yourself and loved ones. We understand the natural hesitation that comes with allocating your hard-earned financial reserves to the “unknown”—but we also know the incredible success that comes from doing so. At Snow Financial we can help you to determine the best investments for you, now and in the times ahead.