Now that we’ve explained what a diversified investment portfolio is and why it’s important for you to have one, it’s time to show you how to add diversity to your portfolio. Let's go back to the food pyramid one more time. As nutritionists understand more and more about the human body, the food pyramid has been tweaked to compensate for individual bodies. It's common sense actually. A marathon runner will have different nutritional needs than a construction worker.
It’s the same with your portfolio.
A 30-year old professional who is thinking about starting their own business is going to have different investment needs than a 56-year old empty-nester who wants to retire at 60. The good news is diversification can be applied to an investor’s portfolio at whatever stage of life they’re in.
Because a diverse investment portfolio is a hedge against risk, it is frequently seen as a strategy that investors only need as they face retirement. But diversification is not just about ensuring we don’t outlive our money. It is just as important for the investor who is saving for college, looking to start a business, or save for their child’s wedding.
As we said earlier, a diversification strategy takes into consideration risk tolerance, investment goals and the timeline for reaching those goals. When it comes to choosing how you’re going to achieve diversity, we should add how much time and interest you have to put towards researching your investments.
One way to build a diverse portfolio is to pick individual stocks and bonds. In this information age, information about publicly held companies is as close as your mobile device. You can also use tools such as MarketBeat Daily Premium to get analysts ratings on individual stocks.
However, many investors don’t have the time, or expertise, to research individual stocks. For these investors, mutual funds are an appealing alternative. Mutual funds invest in a variety of stocks, bonds, or commodities. Sometimes, but not always, they will invest in multiple asset classes. In many cases, you can choose a fund that will balance assets to your goals and adjust accordingly.
For investors whose primary goal is saving for retirement, a great mutual fund option is a lifestyle fund. A fund like this is truly a set it and forget it option. These funds automatically adjust the way your assets are allocated based on your age. So, for example, if you have a 30-year window until retirement you can choose a fund that has a target date of 2050. Initially, this fund will be weighted towards stocks. But as time goes on, it will automatically rebalance the asset allocation to the relative safety of bonds so that the gains you’ve made over the years are protected.
Investors who have more sophisticated needs or who want more control over their investments may choose mutual funds that invest in a single asset class such as small, mid or large cap stocks. These funds will be listed as either having growth stocks or value stocks. There are international funds that specialize in both developed and emerging markets. Bonds offer similar opportunities to diversify depending on an individual’s risk tolerance.
However, like our steak and brisket example, an investor has to be careful here to make sure that they are choosing a variety of mutual funds so that they have exposure to both growth and value across a variety of sectors.