When the economy is expanding and stock markets soaring, it seems almost impossible to sell an asset for any amount less than the purchasing price. However, the economy is ever-changing, making it hard to predict market conditions. It is imperative for investors to have a well-diversified portfolio for any market condition.
Portfolio diversification is a way to safeguard an investment portfolio. It helps investors minimize the bumps and reduce the risks of their investment journey. The broader the diversification of the portfolio, the more stable the returns will be. Therefore, diffusing the overall risk of the investor.
"Diversification does not guarantee better returns or fewer losses. It's simply a technique that can help you reach your long term financial goals," Scott Cohen, CEO of CD Wealth Management in Dallas, said in an interview with U.S. News.
For an investor to truly diversify their portfolio, understanding when an investment should be used is crucial. Money invested in short-term goals should be invested in different ways than funds for long-term goals. Generally, the longer the time frame, the more risk investors can afford to take with the investments.
When building a portfolio, defining your goal, time frame, and risk tolerance are essential. Investors need to build their portfolio in consonance with correlation. Correlation is the degree to which the investments move in tandem. If the entire portfolio moves together, it isn't diversified. Make sure to spread the funds in areas that don't go up and down at the same time.
Although investing in stocks and bonds is a good starting point for diversification, other strategies should be considered. Here are some of them:
Asset allocation is an investment strategy that adjusts the percentage of each asset in an investment portfolio in attempts to balance risk versus reward. The allocation is made according to the investor's risk tolerance, goals and investment time frame. For example, a 70/30 fund will maintain 70% stocks to 30% bonds. Several investment assets can be used for diversification, and it's up to the investors to spread their funds. One thing to keep in mind is that there is no simple formula that can find the right asset allocation for every individual.
Consider index or bonds funds
"An index fund is an investment vehicle which mimics a stock-market index and thus exhibits market risk only," according to a paper published in the Journal of the Operational Research Society.
For long-term diversification of the portfolio, investing in securities that track various indexes can be the right choice. By adding some fixed-income solutions, investors further hedged their portfolio against market volatility and uncertainty. Rather than investing in a specific sector, these funds try to match the performance of broad indexes by trying to reflect the bond market's value. These funds often come with low fees, which means more money for investors.
Most investors are particularly biased toward domestic securities, but to diversify their portfolio, international exposure is needed as well. There are several growth opportunities overseas with global stocks. This is because a country's economic growth varies. International stocks and bonds are playing a significant part in portfolio investing as more economies mature globally.
Instead of sticking to traditional investments, investors can diversify their portfolio by using alternative investments. Alternative investments include commodities, digital assets and even e-sports. These investments can help grow any portfolio, primarily when used with an investment strategy such as arbitrage.
"Arbitrage is an investment strategy that takes advantage of price discrepancies. By employing arbitrage in your assets, you broaden your diversification by trying a strategy that is reliable in any market condition. This helps any investor lessen losses when the economy is in recession," Tony Jackson, CEO of Jubilee Ace, an automated arbitrage trading platform, said.
Know when to get out
A smart investor knows when to pull out an investment. While this isn't going to grow your portfolio, knowing when to get out helps investors incur more losses. Being vigilant with investments is a must for all investors. Understanding the market and knowing the standing of the company is necessary to keep investments afloat.
Investing can be profitable, especially if investors know how to manage their assets. One way to mitigate risks and losses is through portfolio diversification, which Jackson emphasizes: “There are several ways investors can safeguard their investments. Choosing which one suits best with a proper diversification strategy will help in growing their portfolio.”