Wondering how to invest money wisely? While there are no guarantees when it comes to investing. a solid portfolio is a key factor in your success. If you learn how to make your portfolio the best it can be through diversification and risk assessment, you’ll be able to increase your chances for success while simplifying the investment process.
Diversification comes down to choosing the categories of investment you hold in your portfolio. It allows you to stretch out the money you have to invest over several different areas. Instead of putting all of your money in one place, you can allocate it to different styles of investing to reduce your risk while increasing your chances of success. Big events and major losses will create less of a blow when you have successfully diversified your portfolio.
The most common choices, especially for new investors, are stocks, bonds, and cash. Some investors may choose things such as money market funds as an alternative to cash. These categories are often referred to as asset classes and each has defining characteristics that impact the way your portfolio functions.
By choosing to invest in a variety of asset classes, you are creating diversity in your portfolio. As you learn more about the way each category performs, you can make adjustments to enhance your success with investing.
As you get more comfortable with your investment strategies, you will see how each asset class performs. By increasing some and reducing others, you can set yourself up for more consistent investment performance.
When you’re choosing your assets, each type of investment has different risk factors. Subcategories of these investments carry additional risks or benefits, but these factors are the most important to consider when you’re diversifying your portfolio.
Instead of just choosing one type of “asset,” you can choose from “asset classes” which can be thought of as subcategories of each asset type. Some of the most common asset classes are:
While there is no exact combination of assets that will work for every investor, taking the time to add a few of these subcategories will provide diversification to your portfolio. A solid portfolio will have the ability to remain stable for much longer than one that is not well allocated.
A portfolio that is well-diversified shows that you know how to balance risks and rewards.
If you want to see your investments perform while limiting your risk, diversification is not a choice. You must diversify your portfolio to see the best performance instead of just choosing one “safe” investment that you think will work.
In the beginning, putting your money into a single investment may seem like a good choice. It allows you to see returns on the money, gives you a chance to feel like you’re making more, and can be a thrill especially if you’ve never invested before. However, it does increase your risk. If you have limited money to invest, mutual funds are an option for getting access to multiple asset classes with a low initial investment.
The way you allocate your money between asset classes often has more of an impact on your returns than each of the specific investments you’ve chosen.
While performance should be your ultimate goal with investing, the stability of your portfolio is also important and something you must consider when you’re diversifying. A stable portfolio has the ability to stand up to fluctuations in the market and changes with each of your investments.
If you have a diversified portfolio, your risk will not be as great when changes happen to the market. Let’s look at an example:
You’ve invested all of your money into automobiles. Your portfolio seems stable since people will almost always need to buy cars. But a fuel shortage happens that is expected to go on for years. People stop buying traditional cars and turn to electric vehicles, trains, or public transportation. The portfolio value, made up mostly of vehicle investments, drops significantly.
If you had diversified your portfolio by investing in electric vehicles or railways (public transportation may not be an investment option) in addition to the traditional automobile industry, your portfolio would remain stable. Despite losing money from your traditional vehicle investments, you would likely see a boost in your portfolio because of the offset to other asset classes.
It can be hard to predict changes in the future, but diversification is a way that you can help safeguard your investments. While investing might seem scary at first, when you take control and learn the ropes you’ll be prepared and successful in developing your portfolio for long-term results.
Other related posts in our series about facing your investment fears:
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