Diversifying Your Investment Portfolio

Diversification is an important investment principle as it is designed to manage risk with a variety of different investments within a portfolio. It’s a common buzz word in the world of investments, but understanding diversification and the advantages of diversifying your investment portfolio are vital to your investment strategy.

Seek the right level of diversification.

Diversification might seem like an easy objective considering that so many investments are available, but you still need to make smart choices for your diversified portfolio.

Regardless of your means or method, keep in mind there is no generic diversification model that will meet your needs. Risk tolerance, investment goals, financial means, your level of investment experience and your time horizon will play a large role in determining your investment mix. The first step is to figure out the combination of investments that will be required to meet your needs.

Diversification does not guarantee against loss.

However, diversification does not guarantee against loss. It also does not increase portfolio’s performance. What diversification does do is reduce the portfolio’s overall risk without sacrificing its potential return. There is more to diversification than simply spreading your money around in different investments. The key to diversification is to identify investments like stocks, bonds, mutual funds, ETFs or others that may perform differently under various market conditions. That way if part of your portfolio declines, the rest of your portfolio may still grow. Plus, diversification within each type of investment is also important.

A well-diversified portfolio should be diversified both between and within asset classes.

Diversify with a stock portfolio.

A stock portfolio including an IT consulting firm, a software development firm and telecommunication company may appear to be diversified. After all these are three separate companies; however, because of their close relation to one industry, (i.e., technology) it may not be well diversified.

On the other hand, if this same stock portfolio featured an IT consulting firm, a petroleum company and an accounting firm, this may be considered well diversified because the companies vary by industry.

Stocks can be diversified based on many different factors:

• Countries
• Industries
• Business Cycle
• Economy
• Risk Profiles

When you select your stocks, you should make that determination based on those that are different enough from each other, so they don’t risk declining all at the same time.

 

Diversify with a bond portfolio.

A bond portfolio that invests exclusively in long-term U.S. Treasuries would not be considered diversification. The owner of this portfolio should consider adding short-term U.S. Treasuries and corporate bonds to offer broader diversification. That’s because the risk is dependent on the government, agency or company the bond is issued by, as well as the bond’s term­­—the longer the term the higher the interest rate.

Generally, Treasury bills issued by the U.S. government are considered the safest or most stable. Less stable issuers will pay a higher interest rate because they offer a greater risk.

Mutual Funds and ETFs are popular among investors.

The concept of diversification is one reason why mutual funds and Exchange Traded Funds (ETFs) are so popular among investors. Building a diversified stock portfolio as an individual investor can be difficult with lower levels of funds. Many of the most popular stocks are worth hundreds of dollars for a single share.

For example, one share of Microsoft or McDonalds will cost $250, each! Trying to diversify by owning dozens—or even hundreds—of stocks could require tens of thousands of dollars. Mutual funds and ETFs help resolve this challenge by combining many different investors’ money into a pool. The pool of money is invested to pursue the objectives stated in the fund’s prospectus. Every dollar an investor deposits into the fund is automatically diversified since the investor owns a piece of the entire fund.

The fund may have a narrow objective, such as the auto sector, or it may have a broader objective, such as large-cap stocks. ETFs also can have a narrow or broader investment objective. Keep in mind, though, the narrower an investment objective, the more limited the diversification. Furthermore, a narrow investment objective may result in more volatility and additional risks associated with a particular industry or sector.

Diversification strategies vary.

All investors’ circumstances are unique, and your diversification strategy will vary from another’s, but it’s important to understand the concept and why your investment professional may recommend one strategy versus another. If you have questions or would like to schedule an appointment please contact an Associated Bank Private Wealth Portfolio Manager.

Mutual funds and exchange-traded funds are sold only by prospectus. Please consider the charges, risks, expenses, and investment objectives carefully before investing. A prospectus containing this and other information about the investment company can be obtained from your financial professional. Read it carefully before you invest or send money. Shares, when redeemed, may be worth more or less than their original cost.