As you begin building wealth and establishing an investment portfolio, you want to be very active in diversifying your investments as well.
This is an essential process to help ensure your assets are not too heavily focused in one area, which could be disastrous for you as the market shifts.
Sure, when the market is thriving it is hard to imagine anything but amazing gains as you see your portfolio soar.
And the best way to protect your investments and ignore the financial roller coaster is by having a well-diversified portfolio.
Read on to find out why diversification is important for your portfolio, and the simple tips to help you make better investment choices.
Why Should I Diversify My Investments?
Diversifying your investments is a common technique that reduces your risk by allocating assets in different industries and other categories.
The goal is to maximize your returns, yet protect yourself from various market reactions. Ideally, you’d want items that react differently from each other.
For example, if you only invested in stocks and the stock market is entering a bear market, your investments may take a huge hit.
But if you balance that with some bonds and real estate, you’ll be helping minimize impact.
Now there is no guarantee diversification will prevent any loss, but if you are investing for the long-term, it greatly reduces risk and gives you time to recover.
Essentially, the less connection your assets have to one another, the better chance there is for you to succeed during various market turns.
Besides asset variation and industry diversification, you want to consider some location diversity into any investments. When there is volatility in the United States, it may not affect places like Europe or emerging markets.
So when you are diversifying your investments you’ll look for a balance of assets, industries, location, and based on your goals will have certain weight percentages to each.
Diversified Investment Portfolio Example
Although I gave a minor example of diversifying your investments, I wanted to include another example. The best way to show this is to describe my own portfolio right now.
Currently, I’m investing for basically 30+ years still until I’m read to retire. What is great about that is right now I can be a little more risky with my portfolio as I have time on my side.
That said, I’m still very aware and conscious of what I’m invested in.
For example, in my Roth IRA I am invested in stocks, bonds, REITs, and some cash. But here are the index funds I have currently:
- Total Stock Market Index Fund ETF
- Total International Stock Index Fund ETF
- Total Bond Market Index Fund ETF
- Real Estate Index ETF
- Cash in Roth Money Market Account
Each of those areas has a particular percentage invested based on my current goals. But as you can see, it’s balanced in a few areas.
And as I grow my income and wealth, I also plan on investing more outside of these stock market investments.
For example the REIT I have, still tends to follow the stock market ups and downs. But I have other options I’m considering now like real estate crowdfunding, buying actual rental properties, investing in art, or other alternative investments.
Now your portfolio may be different from mine and it may not interest you at all. That is perfectly okay! You don’t need to mimic the exact funds.
Diversifying your investments and how you do it is based on your personal goals, timelines, interests, and knowledge.
Tips for Diversifying Your Investments
Diversifying your portfolio is not a new concept by any means.
If you’ve been passively investing or just getting started, then you probably heard about it at some point via articles, television, books, or your brokerage account service provider.
What is key to remember about diversifying is that is a methodical approach. Too many times investors react to the market and make hasty decisions. This is not what you want to do!
The goal is to diversify from day one (or right now if you realize you are not diversified well) and protect yourself before any corrections or a bear market wreaks havoc on your money.
A great offensive combination is being well-diversified, having a long-term investing horizon, and keeping your portfolio uncomplicated.
(Look back above to my example, I have a whopping four funds in my Roth IRA and will expand to maybe two more outside asset classes).
Here are some simple, yet best tips for diversifying your investments.
1. Spread out your investment types
As alluded to earlier, you want to spread out your investments and ensure you aren’t dumping all your money into one specific area.
Many new investors are sometimes lured into the hype of certain investments and put most, if not all their cash into.
Perfect example was the Bitcoin hype, yet most who invested were putting money into it at new highs. Then took a big financial hit hit when demand slowed down!
This can happen with any stock, index fund, or whatever it may be too.
Like I mention, look at things like index funds, ETFs, REITs, bonds, individual stocks (carefully approach that), cash — and look beyond just your geo investment areas.
I also really like platforms like Fundrise, Diversyfund, and Groundfloor that let you invest in real estate differently from the standard REITs. There are other options for investing in commodities and gold too.
2. Build your diversified portfolio consistently
You may have particular investing strategies in mind, but again I always found the simpler the process, the better it is for your portfolio.
When diversifying your investments you want to keep the process going. And if you have a long-term horizon for your investments, then dollar-cost averaging is a must.
This simple means that no matter what the market is doing, you are investing in your assets the same way on a consistent basis.
So it essentially balances your portfolio out when the market is high and low. And it means you’ll be buying more shares when prices are low, and fewer when prices are high.
Each pay week, I invest the exact same amount into my assets.
Now if the market looks like it is going to crash, I may keep a bit more in cash for potential buying opportunities. But even then, I don’t play the “timing the market” games.
3. Rebalancing to keep your portfolio diversified
While you may have diversified your portfolio early or recently got it set, your work is not necessarily over. As your investments payout dividends, shares appreciate, and you get capital gains — your portfolio can get unbalanced.
Even though you are diversified, you still want to ensure your choices are balanced properly that fit your desired goals.
While you don’t need to tinker with your investments everyday, on some recurring basis you should check in and rebalance as needed.
Personally, I monitor on a monthly basis as my portfolio has increased and become more diversified. But many will do this on a quarterly or even yearly basis.
You can also use a service like Blooom, which has their free analyzer for 401ks and IRAs. It will provide recommendations, show you hidden fees, and more.
If you want to use the Blooom paid service, it will handle all the rebalancing for a few. But you are then hands off!
4. Know when you need to sell
So as you have read earlier, you’ll probably be investing on a consistent basis no matter what the market is generally doing and rebalancing on some cadence.
These are areas that will keep your investments diversified and look great for the long-term.
However, this is not to say there is never a time that you should not sell some part of your investment portfolio. Sometimes consistent investing or buying and holding is not the right strategy for you.
So while keeping things simple is a great way to not lose money, ignoring your portfolio or automatically assuming everything is good can be a grave mistake.
Some investments do not work out the way you intended, and by staying alert and staying up to date on your investments, you can figure out when it’s time to cut your losses.
5. Variety over quantity
I mentioned in a tip earlier in this post, you want to be cautious not to go overboard with your diversification. Which leads us into this last section, picking variety over quantity.
You may think diversification is about investing as much as possible, but you’d be slightly wrong.
The goal of diversifying your investments is to invest in a variety of assets that are manageable and fitting to your goals.
That does mean investing in numerous kinds of assets, but also ones you understand and have time to pay attention too.
Ideally, you want to look at your portfolio and when you see some things are in the red, you should see others are in the green.
And the last thing you want to do is blindly invest your money all over without any real knowledge, plan, or time to truly master your diversification.
So does this mean for you? It means you need to take time to learn about investing, after all this is your money going to work for you!
The other option is to consult with a financial planner or investment advisor, but be sure to review their background and that they have your best interest in mind.
Last thing you want is to hand your money over to losing funds with super high fees.
Signs of Overdiversification
Now that you know the best tips for diversifying your investments, is it possible to be overdiversified?
In a nutshell, yes it absolutely is possible.
There is actually an art form to diversification and it’s not an exact formula for everyone, although there will be overlap of ideas.
If you think you might be diversified too much or concerned you might go overboard, here are some simple signs that signal you are.
- Too many stocks, index funds, or ETFs in the same investment style
- Having an insane amount of individual stocks
- Owning assets outside of the stock market that are pretty much the exact same as your stock market assets
- You find yourself overwhelmed keeping track and are making more investing mistakes with buying and selling
Looking for More on Investing?
If you are interested in learning more about investing and diversifying your portfolios, there are a few great investment books I would highly recommend.
These were the ones I read that helped me learn and have led me to now self-manage all my investments.
- I Will Teach You To Be Rich
- MONEY Master the Game: 7 Simple Steps to Financial Freedom
- Unshakeable: Your Financial Freedom Playbook
- The Bogleheads’ Guide to Investing
- The Intelligent Investor: The Definitive Book on Value Investing
- The Only Investment Guide You’ll Ever Need