The Importance of Diversification
Diversification serves as one of the stalwarts that help investors create a robust portfolio for themselves. The method via which an individual decides to diversify their holdings majorly impacts the growth that they accrue within good markets and the resilience they experience in instances of market volatility. One of the key truths that prevails within the stock markets is the fact that diversification is one of the only tools that provide a sufficient amount of protection. Owing to this very fact it is important that you utilise the correct form of diversification.
Almost every investor that navigates the stock markets has a portion of their portfolio focused on stocks. This is owed to the fact that stocks serve as the primary source of value within an individual’s assorted investments. However, too much direct exposure to the stock market implies that you expose yourself to more losses. By investing in investments that have proven to be historically more stable, you can help offset any realised gains.
Today there exist a ton of financial products available in the market that make it possible to diversify your portfolio with greater ease. By investing in mutual funds and exchange-traded funds rather than stocks alone, you can reduce your exposure to company-oriented downfalls, however, you may still find yourself exposed to sector-wide losses. Moving on, bonds may not perform adequately in instances of low interest rates leading to investors having limited opportunities to make major gains.
In order to really grab at investment opportunities, you need to consider diversifying your holdings via alternative investments.
Diversification Pitfalls to Steer Clear Of
While the importance of diversification has become common knowledge among most investors, not all attempts at diversification pan out the way one would like. In fact, some methods of instilling diversification can lead to more trouble rather than being beneficial. Take for instance the following potential pitfalls.
This is more of a challenge than you might assume. This is because stocks tend to be more volatile in comparison to other forms of investments and can make the margin for errors rather narrow. People are often under the misguided impression that stock diversification simply entails the purchase of a ton of diverse stocks. This is in fact, far from the truth. There are correct and incorrect methods of diversifying stock holdings. Experts recommend that most investors should ideally possess no more than 30 stocks in their portfolios such that they aren’t spread too thin and result in diluted returns. By simply adding stocks to your portfolio for the sake of diversifying, you end up investing your money in something other than top-tier holdings. Keeping this in mind, diversification only ends up bulking up a portfolio rather than providing any value or safety.
Other asset classes such as bonds or investment funds may lack the flash that is tethered to stocks however they provide stable and consistent growth over time. They also provide better protection against stock-related losses and can allow for your portfolio to experience long-term growth. Moreover, they reduce the pressure that your stock holdings might otherwise be faced with.
Like stocks, there exist a wide range of investment funds that proliferate the market today. Furthermore, much like stocks, investors may end up investing in too many funds that overlap with one another. This in turn can lead to investors owning the same underlying properties across multiple funds. Such a scenario may arise due to an accident or could result from a misguided attempt at diversifying holdings within a specific sector or market segment.
By having invested in funds that overlap with one another, you could be robbed of your returns over the long term.
In a bid to diversify your holdings you may also decide to invest in bonds as they provide a guaranteed interest rate in lieu of the investment they provide over a specified time frame. Now, keeping in mind the bond invested in and the issuer responsible for issuing it, bonds can be among the safest investments. However, bonds aren’t perfect and should take on an ancillary role in an individual’s attempts to diversify their holdings.
Examining the Value of Alternative Investments in Diversification
In the event that your assets are primarily tethered to the market, you may not be maximizing your diversification options. Alternative investments come in handy here. They refer to investments that aren’t cash, investment funds, bonds, or stock. They may include exotic holdings ranging from fine wines and rare coins to artwork.
With the aid of alternative investments, it is possible to invest in a host of assets that rise in value that aren’t always directly linked to market moves. This is referred to as “low correlation” which means that it isn’t necessary for these alternatives to rise or fall in terms of their valuation in accordance with stocks. By holding a number of low correlation assets you can preserve value in case the stocks you have invested in begin to lose value. Simply put, alternative investments help buck market trends. While some alternatives focus on stability and steady growth across wide time frames, others allow investors to take on greater risk in lieu of returns that exceed market averages. Regardless of what your threshold for risk might amount to, there exist a wide range of alternative investments that aim to help investors spread out their assets in a wiser fashion.