Diversify Your Investments

Diversification can be neatly summed up as, “Don’t put all your eggs in one basket.” The idea is that if one investment loses money, the other investments will make up for those losses.

 

Diversification can’t guarantee that your investments won’t suffer if the market drops. But it can improve the chances that you won’t lose money, or that if you do, it won’t be as much as if you weren’t diversified.

What Is Diversification?

One way to diversify is to allocate your investments among different kinds of assets. Historically, stocks, bonds, and cash have not moved up and down at the same time. Factors that may cause one asset class to perform poorly may improve returns for another asset class. People invest in various asset classes in the hope that if one is losing money, the others make up for those losses.  The trick of course is figure out which asset class to be at any given time. 

You’ll can be better diversified if you spread your investments within each asset class. That means holding a number of different stocks or bonds, and investing in different industry sectors, such as consumer goods, health care, and technology. To build this diversified set of stocks and bonds can be both time consuming and expensive.

 

If you invest across various sectors of the market if one sector is doing poorly, you may offset it with other holdings in sectors that are doing well.  The really simple way to achieve diversification is to simply invest in three index funds that covers the entire stock and bond market.  This so called "Invest with the Market" approach allows to be fully invested across the U.S. stock market, international stocks and bond markets. 

Some investors find it easier to diversify by owning mutual funds or exchange Traded funds (ETFs). A mutual fund is a company that pools money from many investors and invests the money in stocks, bonds, and other financial products. Mutual funds make it easy for investors to own a small portion of many investments. A total stock market index fund, for example, owns stock in thousands of companies, providing a lot of diversification for one investment. An ETF is similar to a mutual fund, except it is actively traded during the trading day.

A mutual fund won’t necessarily provide diversification, especially if it focuses on only one industry sector. If you invest in narrowly focused mutual funds or ETFs, you may need to invest in several to be diversified. As you add more investments to your portfolio, you’ll likely pay additional fees and expenses, which will lower your investment returns. So you’ll need to consider these costs when deciding the best way to diversify your portfolio. For many investors, especially anyone who wants to keep it simple, just investing with the market is the answer. 

What Is Rebalancing?

Rebalancing is what investors do to bring their portfolio back to its original asset allocation mix.

 

Rebalancing may be needed because over time, some investments will grow faster than others. By rebalancing, you will ensure that your portfolio is in alignment with your investment goals and you’ll return your portfolio to a comfortable level of risk.

For example, you might start with 60% of your portfolio invested in stocks, but see that rise to 80% due to market gains. To reestablish your original asset allocation mix, you’ll either need to sell some of your stocks or invest in other asset categories.

There are three ways you can rebalance your portfolio:

  1.  You can sell investments where your holdings are over weighted and use the proceeds to buy investments for underweighted asset categories.

  2.  You can buy new investments for underweighted asset categories.

  3.  If you are continuing to add to your investments, you can alter your contributions so that more goes to underweighted asset categories until your portfolio is back into balance.  
     

Before you rebalance your portfolio, you should consider whether the method of rebalancing you decide to use would entail transaction fees or tax consequences. Your financial professional or tax adviser can help you identify ways that you can minimize these potential costs.
 

Some financial experts advise rebalancing at regular intervals, such as every six or 12 months. Others recommend rebalancing when your holdings of an asset class increase or decrease more than a certain pre-set percentage. In either case, rebalancing tends to work best when done on a relatively infrequent basis.
 

Shifting money away from an asset class when it is doing well in favor of an asset category that is doing poorly may not be easy. But it can be a wise move. By cutting back on current “winners” and adding more current “losers,” rebalancing forces you to buy low and sell high.