As you’ve likely heard by now, too much of a good thing is a good thing—especially when it comes to investing. Trust us, we know how exciting it is to see your first gains, get your first dividend check, and overall feel like you’re a stock market or investing wizard. But, when you place all your eggs in one basket, it only takes a single market dive or crash to reverse all your gains! *shudder* The good news is there is an investing strategy that helps mitigate the risks associated with the volatility of traditional markets: portfolio diversification. Keep reading to learn more about portfolio diversification and how you can get started.
What is portfolio diversification?
Diversified portfolios consist of a broad spectrum of investments with the goal of reducing the investor’s risk. Examples of strategies for portfolio diversification include owning stocks from many different industries, countries, and risk profiles, in combination with other kinds of investments, like bonds, real estate, and commodities. The array of assets works in conjunction to reduce the investor’s overall risk of permanent capital loss and the volatility of their portfolio. The downfall is that diversified portfolio returns are socially lower than what investors who stick with a single winning stock earn.
Gain the following benefits from diversifying your portfolio:
- Lessen your risk. If you put all your money into the stock of one or two companies and they plunge, you lose all your money! Diversification is key to limiting the risk associated with these types of scenarios by choosing many different investments and kinds of investments.
- Preserve capital. Not all investors are young with plenty of time for their assets to appreciate. For investors who are close to retirement and who are trying to preserve capital, portfolio diversification is an excellent way to help protect their savings.
- Generate returns. Much to our chagrin, investments don’t always perform as they’re expected. When you diversify your portfolio, you stop relying on one source of income and increase your rate of return.
How to diversify your portfolio?
To start diversifying your portfolio, try the following investing tips:
- Purchase 25 or more stocks across varying industries. This is important because if tech spending takes a dive due to a slowdown in the economy or new regulations, every single tech company you invested in is likely to plummet. This is why it’s not enough to purchase 25 stocks from companies in the same industry. You must purchase stocks across industries to have a diversified portfolio.
- Invest in an index fund. One popular index fund is the S&P 500. Index funds have a distinct advantage in that they take most of the guesswork out of investing while still offering investors instant diversification. Index funds also have low fees since investors are not paying for a fund manager’s expertise.
- Consider putting a portion of your portfolio into fixed-income assets, such as bonds. This is an important step in the diversification process as it reduces a portfolio’s overall returns and therefore lessens the portfolio’s volatility and overall risk profile.
- Go global. International markets bring the potential for high returns fast because these markets often move extremely quickly. A good place to start is an exchange-traded fund (ETF) or mutual fund.
- Invest in real estate. Real estate is an excellent addition to any investor’s mix for a number of reasons, including the fact that it historically increases the total return of a portfolio while simultaneously reducing its volatility. An easy way to invest in real estate is with an online platform, like Ark7, that connects investors with investment properties with the click of a button. Say hello to reaping the benefits of real estate investment without having to perform landlord duties.
Diversifying your real estate portfolio
It’s no secret that real estate is one of the most lucrative asset classes. Famous billionaire Andrew Carnegie once said that 90% of millionaires got their wealth by investing in real estate.
Real estate is also an excellent way for investors to diversify their portfolios. There are many different types of properties you can invest in, each with its own unique set of pros and cons.
Multifamily properties
“Multifamily properties” is the term for residential housing with two or more units under one roof—it’s actually the least common kind of residential building. But multifamily properties attract investors because they can produce bigger cash flows than single-family rental properties do.
Some of the advantages of investing in multifamily properties include:
- Less risk. The biggest risk for rental properties is the loss of income that happens when a unit is vacant. Since multifamily properties have more units, they automatically alleviate the economic loss when vacancies pop up, allowing for fewer losses for investors.
- Cash flow. Multifamily properties generate much more cash flow than single-family units do.
Commercial properties
Office buildings, shopping malls, and warehouses are all under the commercial property umbrella. Benefits of investing in commercial properties include:
- Less competition. Commercial properties require a lot of work and capital from investors upfront. This makes the space far less crowded than some of the other, easier-to-acquire property types. But commercial properties are well worth the investment for smart investors who are capable of handling the workload.
- Triple net leases. Tenants pay the building’s taxes, insurance, and maintenance costs in addition to their monthly rent. This cuts down on the cost for the property owner.
- Cash flow. Commercial property investors have a distinct advantage over other investors because commercial leases are typically longer than residential rentals. This allows the investor to earn a consistent and reliable income on a month-to-month basis. What’s more, commercial real estate generally earns better ROI than single-family homes.
Final thoughts
Diversification is a strategy where investors choose a wide range of assets to invest in. It’s a great way to help you protect your investment portfolio from risks like underperforming assets while also boosting your chances of investment growth and dividends. Diversified portfolios help your overall investment portfolio absorb shocks from any financial disruptions that may arise.
It’s important to remember that portfolio diversification is not a set-it-and-forget-it, one-time deal; it requires some legwork. It’s important that you keep up with your target mix to ensure it stays on track through checkups and rebalancing. Neglecting to rebalance could leave you vulnerable to missing out on gains from fluctuations in your portfolio.
To ensure a properly diversified portfolio, invest in a wide range of industries, tenures, countries, and interest plans. Don’t limit your investments to one industry or sector.
