The Keys to Diversifying Your Portfolio
As a new stock investor, especially if this is your first time as a DIY (Do it yourself) investor, you are most likely wondering what the whole "diversification fuss" is all about.
After all, it’s being said that buying one or two Mutual Funds gets you invested in dozens of stocks or bonds. And that's what a lot of new investors do.
So now they’re diversified – right?
Wrong! Simply buying a bunch of Mutual Funds, Indexed Funds or ETF's does not necessarily lead to diversification. You've heard the term "Never put all your eggs in a single basket". Well, the key to a well diversified portfolio is taking that saying to heart, and building it further.
Here's what you need to know about diversifying your portfolio.
Know what you need (not want!):
Sure, everyone wants a portfolio that returns high double-digit gains. And, we all want our investments to be 100% risk free.
But believe it or not, that's not always what you need! What you really need to diversify your portfolio can only be figured out by doing a need's analysis: What stage of the investment cycle are you in? What your time horizon is? Are you investing for long-term income? Are you looking to fund a short-term goal? Do you need safety of your capital over risk of gains?
Armed with this knowledge you can then start putting the building-blocks of a truly diversified portfolio together.
Know what's out there:
Now that you know what you need, it's time to find out what will fulfil those needs.
The more you know about the diversified nature of products and services available to fit your needs, the better your chances are of building a diversified portfolio using those products.
Depending on your needs, it might be that a portfolio of Mutual Funds might be the right answer for you. Alternately, if you are aware of other products (CD's, Bonds, ETF's), then take a look at them carefully to see if they might help you diversify your portfolio.
Know what's right for you:
Armed with a list of your needs, and the various products and services available to fulfil those needs, it's now time to assess which one (or several) of these products are right for your diversified portfolio.
Some products out there will fit your needs, but they may not necessarily be right for you. A diversified portfolio does not simply mean "picking some of everything", but rather making picks of different asset combos that you are comfortable owning.
Know where your money is:
Having all of your investments tied to a particular geographic region is often a temptation that fuels non-diversified portfolios.
To diversify, you need to get over "home country bias", and go further afield.
However, while being in riskier regions of the world might promise higher returns and better diversification, it might not always be the best portfolio strategy for you.
Know about emergencies:
No one really knows when an emergency will strike, or what its nature will be, but prudence dictates that you must plan for one.
As is often the case, emergencies can better be faced when you have access to cash.
A diversified portfolio should also include an element of liquidity which, if and when needed, can quickly be converted into cash.
Know when you need help:
While all of this seems like straightforward common sense, some of us still feel overwhelmed when putting it into practice.
If you are an investor who is uncomfortable dealing with all of these "knows", then that's a sure sign that you need professional help to construct a diversified portfolio.
Diversification – The key to sleeping well!
A well diversified portfolio is one that doesn't require frequent radical and structural changes.
You also don't need to watch it daily. But diversification does not mean you build it and forget it either.
"Diversification" is relative to your stage in life, your current status (financially, socially, professionally), and your personal outlook on the economy and global affairs.
If any of these elements change significantly, you need to rebalance and "re-diversify" your portfolio.
However, if you follow the advice provided above, you'll be able to construct a personalized and well diversified portfolio that weathers the day-to-day gyrations of the markets.
But above all, a properly diversified portfolio gives you peace of mind and helps you sleep at nights!