TrueNorth Explains: Diversification
How often do you think about moving around your investments or reducing risk? If your answer is "not very frequently" and you want to increase your investment earning potential, then you will want to consider diversification.
Successful diversification consists of distributing money among several asset classes (also known has asset allocation.) The three main asset classes are:
- equities (stocks)
- bonds
- cash equivalents (such as CDs and treasury bills).
- Some investors also diversify by investing in asset sub-classes like mutual funds or other pooled arrangments.
Once you have diversified your investments within each category, how much you invest in each major category is your most important decision and should define your investment strategy.
The assets an investor chooses depends on his or her level of risk.
For example, a 57-year-old investor with $850,000 in savings will not want to take a lot of risk, given the fact that retirement is looming. His or her goal would be to maintain that nest egg. Such an investor would want the majority of his or her portfolio in low-risk options, such as bonds. On the other hand, someone who just got his or her first job out of high school or college can afford to take significantly more risk than the soon-to-be retiree. This high-risk investor should place most of his or her savings into stock. This is because stocks are much more predictable over the long run than they are in the short-term. It would also be wise for the investor to allocate some money for bonds for the periods in which some stocks are losing money.
In general, when stocks are down, bonds are up; when bonds are down, stocks are up. Diversifying among stocks and bonds provides the investor the best chance to maximize investment earnings.
Why Diversify?
The purpose of diversification is to guarantee that no matter what, the overall outcome of your portfolio is steady. By distributing investments among a variety of assets, it is likely the fluctuations of each will cancel each other out. At any given time one investment might do better than another.
Diversification lets you manage your risk in a particular investment or category of investments and decreases your chances of losing money. While the final payout may end up being a little less than what an undiversified portfolio would contain, it also comes with a lot less instability. Over a long period of time, the risk of losing money or earning less than you would in a savings account tends to decline.
When you are making investment choices for your 401(k) assets or other personal assets, make sure you mix a wide variety of investments within your portfolio. By diversifying, you can expect higher returns and lower risk.
We're Here to Help
For more information and financial guidance, please call TrueNorth at 1-800-798-4080. Our financial advisors would be happy to schedule a consultation with you and your loved ones to make sure the things that matter most are protected and accounted for.