Diversification is a word that gets thrown around a lot when it comes to investing. But how many investors really understand what diversification means?
In this article, we’ll cover the basics of rebalancing your portfolio, including why it’s important and how often you should do it. We’ll also take a look at some of the different types of investment diversification available to help protect your assets.
Read on to explore answers to investment-related questions, including:
- What’s the main problem with going all-in on one type of investment?
- What should you consider when deciding how often to rebalance your portfolio?
- Which of the three types of diversification is most common?
- How can a CERTIFIED FINANCIAL ADVISOR™ help?
Want to learn more about asset and wealth management? Feel free to read our comprehensive blog on why retirement planning is a vital part of growing your wealth.
Why is diversifying your portfolio important?
Diversification is a fundamental concept in the financial world. It means that you’re spreading your money across different types of investments to help reduce risk and maximize returns.
For example, if you had 100% of your money invested in stocks, it would be very risky because there’s no guarantee that the stock market will perform well.
Conversely, if you invest some of your money in bonds and other conservative investments which tend to perform poorly when stocks are doing well you may be better equipped to handle an economic downturn or a period of high inflation.
In addition to minimizing risk, diversification can also help reduce taxes. When one asset class performs poorly but another performs well during the same period of time, investors may be able to shelter gains from taxation by using rebalancing strategies.
Don’t put all your eggs in one basket.
This fundamental principle lies at the core of diversification and is one of the most important rules of thumb for investors.
It’s common for investors to feel tempted to go big on one type of asset and chase a big payoff, but that’s rarely a wise plan.
Instead, successful investing is a matter of patience and discipline, ensuring that you have a proper balance of various assets within your portfolio.
How often should you balance your portfolio?
The frequency of rebalancing depends on a number of factors, including your risk tolerance, investment goals, and market environment. Another consideration is how long you plan on holding the investments in question.
Spreading out the taxes among each of your investments is another important reason to rebalance your portfolio. Assets that levy a tax should be balanced with tax-advantaged investments to ensure that taxes don’t drain too much of your nest egg.
Three types of diversification
When you decide to rebalance and update your portfolio, it helps to know the various options available for making it happen. Explore the three types of diversification and consider how each of them may be used to improve your portfolio:
1. Investment diversification
Investment diversification is the process of spreading your investments over several different asset classes, each with its own risk and return profile.
This method helps investors avoid putting all of their eggs in one basket, so that if one type of investment performs poorly, another may perform well enough to balance it out.
Investment diversification also allows for more consistent returns and decreases the chances of an individual stock or asset class draining your entire portfolio.
2. Term diversification
Term refers to the length of time you plan on investing or holding onto an investment. For example, you could have a short-term portfolio that lasts for one year or a long-term portfolio that lasts 10 years or longer.
Another effective way to diversify is by the maturity dates of your assets. This process is called term diversification, and it can be a useful strategy for balancing out your portfolio.
An example of term diversification would be if you invest in a Treasury bond that matures in 10 years and an investment-grade corporate bond that matures in 30 years—both of which have similar yields but different maturities.
3. Advanced diversification
Advanced diversification focuses on the type of investments available to you within each category rather than simply spreading them across different industries and sectors.
If you were only investing in stocks, then a downturn in the stock market could wipe out your savings. Diversifying into other types of investments as well, like bonds and real estate can help stabilize your portfolio.
Advanced diversification could even involve investing across different countries and regions around the world. With the US economy struggling from record high inflation, investing in markets with a stronger currency could be a prudent strategy.
A financial planner can help you protect your assets
If you are serious about retiring early, it’s important to have a CERTIFIED FINANCIAL PLANNER™ on your side. A CFP™ can help you create a financial plan that allows you to invest in different types of assets and achieve your personal goals.
A good financial advisor will also help ensure that all of your investments are diversified so one particular type or sector doesn’t take too much away from the rest of your portfolio.
Whether you need to make sure your portfolio is on track for retirement, or you want advice on planning your estate, the right professional can give you the edge you need. Not to mention saving you time and preventing you from making a critical mistake.
Experience the advantage of working with Ascendant today!
When you’re ready to free up your time for the things you love most, our professionals at Ascendant will be waiting. We specialize in helping you plan your retirement, manage your taxes, and make investments that can grow your wealth. Connect with us at your convenience to set up your first appointment.
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