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Why, What, How: Diversifying Your Investment Portfolio

    

SUMMARY: There are many places to put your hard-earned money, but the one thing all experts agree on is that a diversified portfolio is essential. Here's how, what, and why when it comes to diversifying your portfolio. 

Whether you’re a seasoned investor or have only considered dipping your toes in the water, chances are that one word comes up again and again—diversification. There are many ways to approach the markets and many places to put your hard-earned money, but the one thing on which all experts agree is that a diversified portfolio is essential to positive returns over time.

But where exactly should you stash your cash? How much risk is too much? When should you stay in and when should you take your winnings and go? The secret sauce varies depending on your short-term needs and long-term goals, but here are the essential components that your investment portfolio should consist of.

diversifying investment portfolio

Stocks

When a company needs income that it’s not getting from its own operations, it puts pieces of itself up for sale in the form of shares. The more shares you own, the more rewards you can reap when the company does well, and the more risk you assume when the company’s fortunes take a dive.

Stocks are an ideal vehicle for long-term goals such as retirement. They bring higher rates of return than other investment vehicles and are well-poised to ride out any increases in inflation.

Income from stocks comes in two forms:

  • Dividends: These provide taxable income on a reliable basis with payments that come quarterly or annually.
  • The sale of shares on the open market: Prices will vary as stocks trade throughout the day.

Bonds

Unlike stocks, where your money buys a portion of a private company, with bonds you provide a loan to a government body or organization that it agrees to pay back with interest. Bonds are generally considered to be less volatile and, therefore, also less lucrative than stocks. They are a reliable place for a portion of your dollars to sit comfortably earning semiannual interest while the stock portion of your portfolio runs wild in search of high returns.

Bonds provide healthy diversification within your portfolio, as they usually follow trends that are opposite to stocks. When one falls, the other typically rises or stays level, which allows for a certain amount of stability. Downturns in the bond market are less common and usually far less dramatic than those of stocks.

Cash

While not nearly as sexy as stocks or bonds, low-risk, cash-based investment options are an essential part of a diversified portfolio.

These may include but are not limited to:

  • Money market mutual funds: Professional traders and analysts package your cash into a series of safe, low-return investments.
  • Bank savings accounts: These are the easiest to self-manage and come with full FDIC insurance. The money is yours to withdraw at any time, with no penalty or fee.
  • U.S. Treasury-issued securities: These include Treasury bonds, savings bonds, bills and notes. You can purchase one for as little as $25, and they are one of the safest and most reliable investments available.
  • Certificates of deposit (CDs): Like bank savings accounts, CDs are safe and FDIC insured, but they require a higher minimum investment (usually around $1,000).

While stocks, bonds and cash are the basic building blocks of most portfolios, they are by no means the only tools available on the road to diversification.

Immediate annuities

If you’re looking for steady, annual income that is immune to the market’s fickle fluctuations, an annuity may be right for you. Annuities are contracts sold by insurance companies that pay constant tax-deferred income, protect against inflation and provide a guaranteed minimum death benefit.

Retirement income funds

Also known as managed payout funds, these collections of mutual funds encompass a wide range of stocks and bonds that facilitate dependable monthly income. The key difference is that you retain access to your principal investment (but withdrawals bring down any future payments).

Real estate

Some investors prefer to step outside the market and hedge their bets in rental property. Whether residential or commercial, real estate can provide steady income, assuming you know the risks and plan for regular upkeep, last-minute expenses and the occasional vacant property.

If all of that sounds a bit too involved, consider a real estate investment trust (REIT), in which a team of professionals handles all the details.

The Goldilocks blend

There are many schools of thought on the proper mix for a healthy, diversified portfolio, but the ideal blend is unique to each investor. Is retirement your top concern? Then lean into stocks and take the risk that comes with higher returns. Will you need more immediate cash to replace that worn-out car or sewage system? Then a conservative mix may be best.

With so many choices at your fingertips, it’s helpful to consult an expert. Our checklist can match you with a wealth advisor who’s aligned with your financial goals.

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