Not diversifying your investment portfolio is the financial equivalent of putting all your eggs in one basket. It is a high risk bet that could ultimately result in losses. On the other hand, a well-diversified portfolio is likely to generate the greatest gains over time, especially when previously strong market sectors begin to falter while others begin to experience growth. Learning how to build your portfolio with diversity protects your investments and positions you for long-term capital gains.
How to build your portfolio
As you learn to build your portfolio, correlate your risk to your long- or short-term goals. Let’s say you’re a 45-year-old woman with $75,000 saved in an IRA and you’d like to invest it to maximize your retirement earnings. Assuming you decide to work another 15 years until you’re eligible for retirement withdrawals, giving you plenty of time to weather potential market fluctuations, you may want to take a moderately aggressive approach to your investments to build a diversified portfolio. For example, you’ll probably want to put about 50 percent of your portfolio in stocks, as they have the greatest potential for growth. Put about 40 percent of your portfolio in securities, such as government bonds, and leave the other 10 percent for your cash savings. As you get older, increase your values and decrease your shares to reduce your risk.
types of diversification
In addition to the types of investments you participate in, you should also divide your assets within those types of investments to further maximize your earnings and protect yourself from volatility. A diversified portfolio has investments that complement each other by providing balance to each other’s weaknesses. Low-risk bonds offset high-risk stocks, and a variety of stock types offset the collapse or prolonged recession of any particular industry.
For example, with respect to stocks, a properly diversified portfolio includes several stocks from various financial sectors. A market sector is a grouping of commercially related stocks. Examples of market sectors include agriculture, medical fields, and technology. By spreading your stock investment across many different sectors and types of stocks, you protect your savings from unexpected losses. Additionally, using bonds and stocks in your portfolio provides stability in the event the entire stock market crashes or experiences a long-term bear market with negative earnings. You may also want to incorporate a variety of small- and large-cap stocks, as well as a mix of domestic and international stocks, stocks, and cash, which can protect you from a weak dollar or provide gains if international countries experience an economic boom.