SUMMARY: Whether your primary focus is retirement, saving for your children’s college education, worldwide travel or all of the above, diversifying your investment portfolio is an absolute must. Here’s what that could look like.
You’ve no doubt heard it many times as you’ve put your money to work in the markets—diversification is the key to long-term investment success. There are countless variations on this theme and many ways to make it work for you, no matter your level of investment or financial goals.
Whether your primary focus is retirement, saving for your children’s college education, worldwide travel or all of the above, there’s a handful of pieces you’ll need to complete your diverse portfolio puzzle.
Start off with probably the least sexy option—low-risk, cash-based investments. Even though they can be decidedly unexciting, they are a crucial first step on the road to a diversified portfolio.
The most common options are:
- Bank savings accounts: You can easily manage these without professional help, and they are fully FDIC insured. Whenever you need the money, it’s yours to take, no fees, penalties, or questions asked.
- Certificates of deposit (CDs): Similar to bank accounts, CDs are FDIC insured and very safe, although they do require a higher investment (usually around $1,000) to get started.
- Money market mutual funds: If you want professionals to get involved, analysts and traders will structure your cash into a series of safe, low-return investments.
- U.S. Treasury-issued securities: These are very affordable (as little as $25) and include savings bonds, Treasury bonds, notes and bills. By far some of the safest and most reliable investments in your toolbox.
Although some companies earn what they need solely from their own operations, many need additional funds to achieve their goals. One way to accomplish this is to sell off pieces of the company in the form of shares that are available to the general public. The more shares you buy, the larger a piece of the company you own. If it performs well in the marketplace, you get a piece of the action. But if it stumbles and falls, your money goes down with it.
There are two ways that stocks bring you income:
- Sale on the open market: Traders sell shares of stocks and their prices vary throughout the day.
- Dividends: The company pays you reliable, taxable income quarterly or annually based on its performance.
Despite the risks, stocks provide the highest rate of return of any investment option and can handle inflation with relative ease. As such, they are a reliable way to save for retirement, which requires the ability to generate wealth over many years.
Instead of purchasing a piece of a business, bonds allow you to loan money to a government organization that it will eventually pay back with interest. Bonds tend to sail on calmer waters than stocks and are therefore considered to be safer and less volatile. The tradeoff here is that they can be far less lucrative than their stock brethren. But they do provide a relatively safe haven for a portion of your money to bring in semiannual interest, as your stocks hungrily roam the markets, on the hunt for major returns.
A bond is a particularly valuable tool in your quest for diversification because it tends to have a different trajectory than a stock. As one plummets, the other often soars or stays fairly stable. The bond market is also far less susceptible to major downturns.
Cash, stocks and bonds are typically the starting kit for diversifying your investment portfolio. But it doesn’t have to end there.
Need a break from the markets? Many investors find success in residential or commercial rental property. Once you account for upfront and ongoing costs (and vacancies), it can become a cushion of steady income that supports your market-based investments.
If you’d rather leave the details to the experts, a real estate investment trust (REIT) may be a useful option.
Retirement income funds
If you want a reliable monthly income in retirement and also the ability to access your initial investment, this may be a good place to start. These collections of mutual funds (or managed payout funds) contain a diverse mix of bonds and stocks. The one downside? Any money you take out now brings down the amount you have for retirement later.
Many roads to success
What’s the best path to a diversified investment portfolio? What gets you to that Goldilocks place, where everything sits just right? The answer depends on your personal financial needs and long-term goals. Do you need cash soon for immediate expenses? Or are all of your eggs going into the retirement basket?
Regardless of what direction you choose, it’s always helpful to have a guide. Our roadmap to retirement provides free planning tools to show what’s possible.