Failing to diversify your investment portfolio is the financial equivalency of putting all of your eggs in one basket. It’s a high-risk gamble that could ultimately result in losses. On the other hand, a well-diversified portfolio is likely to yield the highest gains over time, especially when previously strong market sectors begin to falter while others begin to experience growth. Learning how to build your portfolio with diversity protects your investments and positions you for long-term capital gains.
How to Build Your Portfolio
As you learn how to build your portfolio, correlate your risk to your long or short-term goals. Let’s say you are a 45-year old woman with $75,000 tucked away in an IRA, and you would like to invest it to maximize your earnings for retirement. Assuming you decide to work another 15 years until you are eligible for retirement withdrawals, which provides you with plenty of time to ride out potential market fluctuations, you may want to take a moderately aggressive approach to your investments to create a diversified portfolio. For example, you’ll likely want to place approximately 50 percent of your portfolio into stock equities, as they present the most potential for growth. Place approximately 40 percent of your portfolio into securities, such as government bonds, and leave the other 10 percent to your cash savings. As you age, increase your securities and decrease your equities to lower your risk.
Types of Diversification
In addition to the types of investments you participate in, you should also divide your assets within those types of investments to further maximize your gains and protect yourself from volatility. A diversified portfolio has investments that complement each other by providing balance to each other’s weaknesses. Low risk bonds offset high risk stock equities, and an assortment of stock types counteracts the collapse or prolonged downturn of any one particular industry.
For example, with regard to stocks, a properly diversified portfolio includes several stocks from several financial sectors. A market sector is a grouping of stocks commercially related. Examples of market sectors include agriculture, medical fields and technology. By spreading your stock investment across many different sectors and types of stocks, you safeguard your nest egg from unexpected losses. Additionally, using bonds and securities in your portfolio provide stability should the entire stock market plummet or experience a long-term bear market with negative gains. You may also want to incorporate a variety of small cap and large cap stocks, as well as a combination of domestic and international securities, equities and cash, which can protect you from a weak dollar or provide gains should international countries experience an economic boom.