What do fruit baskets, all-you-can-eat buffets, and efficient portfolios have in common? They all have variety, so should your portfolio after you diversify investments.
Diversifying is the process of spreading money among different kinds of investments. It means that you don’t put all your eggs in one basket. Through diversification, it is possible to increase your chances of success by investing in some assets. You also decrease your chances of losing all of your money when times get tough.
Diversify Investments in Your Portfolio
Your financial assets do not need to be purely stocks in companies; there are many financial vehicles that you can take advantage of. Here are a few that can help you maintain a balanced diet of risk, profit and growth potential.
A stock is a security that shows ownership in a company and represents a claim on a company’s assets and earnings. By buying stocks in a certain corporation, you own a certain percentage in that company.
In the stock market sector, there are different types of stocks you can diversify with. There are categories depending on the industries they operate on, like utilities and banking. Another categorization is in their market value, from the small cap ($300 million to 2 billion) mid-cap ($2 billion to 10 billion) and large cap ($10 billion and up).
If all you want is to diversify in buying stocks, go for companies that are not in the same category with different valuations. Large-cap stocks usually have lower risk but also a lower potential for growth, unlike small caps which have higher risk but higher reward.
Mutual Funds and Exchange Traded Funds (ETFs)
Mutual Funds and ETFs are both a pool of investments that bring many investors together and hold many different stocks or bonds. There are differences between them though.
Mutual funds have fund managers who also take a fee in administering them. With a mutual fund, you can be sure that the fund will invest in companies which the managers have researched thoroughly. In a sense, a mutual fund is where investors trust their money to a professional manager. The value of a mutual fund usually shows up only after market hours, so if you buy or sell some of your mutual fund shares, you will only know the value after the stock market closes.
ETFs, on the other hand, are financial vehicles where people pool their money to buy a set of stocks in companies in a group, like from the technology sector or the mining industry. There are also ETF’s for valuations, like a small-cap fund, and other interesting groupings like foreign businesses or exporting industries. There are no managers. Hence the fees are limited or minimal. ETFs are traded like stocks as well, so you can easily buy or sell them and they are a great tool to diversify investments.
A bond is a fixed income investment where an investor loans money to a corporation or government. These entities borrow the cash for a certain period at the fixed or variable interest rate. Bonds are debt assets, so the bond owner, not the shareholder, gets paid first, in case of bankruptcy. This makes bonds very low-risk compared to stocks and ETFs.
Government bonds are the safest investments you can venture into since the government can print money or use their reserves in case the budget is not enough. Companies can also offer bonds, and there are grading agencies that analyze how trustworthy companies as debtors are, and can even grade bonds according to their desirability with the term, rates and loan amount needed. If you have heard of an AAA rating for a bond, that means that the bond is treated as the best of the best.
Usually, bonds are always inversely proportional to stocks. This means that returns on bonds increase as stock prices decline. This phenomenon happens because when there is a decline in stocks prices, investors will run to get treasury bonds, thus increasing the bond price by increasing demand.
Variety is the spice of life, and diversity is the spice of your portfolio. By mixing up your financial asset classes as well as percentages, you can be both prudent and smart when you diversify investments. If stocks are too expensive, you can go with fractional shares through Stockpile instead, which is a great place to start for those who are still learning about finance and investing.