We’ve all heard the adage, “Don’t put all your eggs in one basket.” Diversifying your funds helps to mitigate risk in a portfolio. Fidelity’s experts typically recommend diversification among and within asset classes. That means investing in different stocks (small, mid and large caps) and across industry sectors and geographic regions, and varying bond durations and credit qualities.
1. Diversify by Asset Class
The most basic form of diversification is spreading your investments among different asset classes. These include stocks, bonds and cash. When determining your asset allocation, it’s important to consider your investment goals and time horizon.
It’s also important to diversify within each asset class. For example, when investing in stock, it’s beneficial to invest in a variety of sized companies (small, medium and large), sectors and geographic locations. Additionally, when purchasing bond investments, it’s recommended to purchase bonds from multiple issuers including the federal government, state governments and corporations, as well as varying maturity dates.
Diversifying your funds can help you save money by reducing the impact of market fluctuations on your portfolio’s overall expected returns. However, remember that no diversification strategy can eliminate all risk or guarantee a positive return. To learn more, contact a Marsh McLennan Agency Retirement & Wealth Consultant today.
2. Diversify by Sector
Even within a single asset class, diversification can save you money. This is one reason why many investors turn to pooled investments like mutual funds and exchange-traded funds, which often include a much wider range of underlying investments than you could assemble on your own. Find out more at diversify your funds.
You can also diversify by industry, which can help lower overall portfolio risk. For example, if you want to hedge against negative effects of pandemic-related travel shutdowns on airlines, you might invest in railroad stocks (negatively impacted by travel shutdowns) at the same time as you hold positions in digital streaming companies (positively impacted by more people staying home and using technology).
You can also consider other low-correlation asset classes, such as bonds and commodities, as well as alternative investments, such as real estate and cryptocurrency. However, be careful when adding these assets to your portfolio. Each will come with different risks that must be considered on a case-by-case basis.
3. Diversify by Industry
We’ve all heard the adage “don’t put all your eggs in one basket” – and diversifying your funds helps you save money, too. Diversifying your portfolio by asset class and even within each asset class can help you reduce your risk and achieve better returns over time.
Within the stock portion of your portfolio, it’s a good idea to diversify by market capitalization (small-, mid-, and large-cap companies); sectors like technology, health care, and energy; and geographic regions. You may also want to diversify by investment style — for example, growth versus value stocks.
It’s important to remember that true diversification involves assets with low correlation, which means they don’t move up or down together during different market conditions. Investing in mutual and exchange-traded funds (ETFs) that track broad indexes is an easy way to build a diversified portfolio at a relatively low cost. The best part is that these funds automatically rebalance as their holdings change over time, giving you more stable long-term performance.
4. Diversify by Country
Diversification is a key investment principle that can help reduce risk and increase returns. It involves spreading investments across different asset classes, such as stocks and bonds, to lower the overall correlation between them. This can mitigate losses if one investment performs poorly. For example, if the price of oil declines, the share prices of multiple energy companies could decrease simultaneously, but a country fund that diversifies your investments in energy stocks could minimize the impact on the total value of your portfolio.
Diversification can also extend to geographic regions, with different countries having varying economic cycles and political climates. This can provide protection against localized downturns and enhance potential growth opportunities. However, if taken to the extreme, this diversification can lead to higher management costs and miss out on sector- or industry-specific above-average returns. In addition, too much overlapping exposure can make it difficult to track and manage your portfolio. Therefore, you should seek to find a balance that suits your investment goals and risk tolerance.