Articles: Back to Basics: How to Diversify
How can you protect yourself against the inherent volatility of the equities markets in this uncertain economy? No matter what anybody says, even the so-called “experts,” there is no 100% foolproof method. But proponents of diversification often rely heavily on this fundamental investment principle to help minimize risk.
In a nutshell, diversification is the process of including different kinds of investments such as stocks, bonds and cash alternatives in your portfolio. It also means that you should maintain a mix of investments in different sectors or industries. For example, you might view investments in international stocks as a way to offset domestic stock risks, realizing that such investments raise special risks. The basic concept is to try to reduce overall risk, as opposed to “placing all of your eggs in one basket.”
Caveat: Even if you rely on fundamental investment principles such as diversification, you are not protected against the potential for an overall loss in your portfolio. There are no absolute guarantees, and you must recog nize the inherent risks involved with your investments.
The concept of diversification is often combined with an asset allocation strategy that divides up your portfolio based on your needs and objectives, as well as your personal tolerance for risk. You can rely on experienced financial pro fessionals to help you develop the general parameters.
As part of the diversification process, you should determine
- your investment goals
- the time horizon for reaching these goals.
- the amount you can currently afford to invest
- the amount you can afford to invest in the future
- the amount you need to generate to reach your goals
- the level of risk you are willing to assume in pursuit of your goals
Of course, everyone’s situation is different. The exact methodology you might use to diversify your portfolio should be tailored to your particular circumstances. For example, a single 25-year-old embarking on a new career or a 30-year-old newlywed starting a family will likely opt for an investment mix different from a married 50-year-old professional with a couple of children in college or a 60-year-old with retirement looming. Furthermore if you are already retired, protecting principal will take on added significance, as opposed to trying to grow your investments.
It is also important to monitor your investments to avoid having the asset allocation stray off course. If this occurs, you may want to adjust the current allocation or re-think the stated percentages. In addition, your situation may be affected by life-changing events such as getting married, or divorced, having a child, switching jobs or careers, starting your own business or retiring. Although these events tend to occur at “busy” times of your life, don’t ignore their impact.
Reminder: You don’t have to go it alone. Rely on a trusted financial professional to provide guidance in developing a strategy.
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