Everyone knows an investment portfolio should be diverse. You should invest in a variety of products so all your eggs aren’t in one basket. But what counts as diverse? Would it be diverse to put half your money into Tesla stock and half into Meta stock? How diverse is diverse enough? We’ll talk today about the different ways investments can be diverse and the types of diversity you should build into your portfolio.
Why Should Investments Be Diverse?
Diversity in your portfolio can make the difference in a bad market between losing something and losing everything. We often talk about “the economy” doing well or doing badly, but in reality, the economy is a complex machine with many moving parts. At any given time, parts of it are doing well and parts are doing badly.
In the long run, they all tend to correlate with one another. A housing crash will eventually drag down employment, for instance. But, when building a portfolio, you want to combine investments that correlate with one another as little as possible.
The less your investments correlate with one another, the better the odds that when one of your investments tanks, the rest will cushion the blow.
Diversity in Industry or Sector
One type of diversity to pursue in your portfolio is the industries you invest in. For instance, when buying stocks, you wouldn’t want to buy only oil-industry stocks. They would all be vulnerable to the same kinds of problems, like a new emissions law or a war in the Middle East. But you wouldn’t want to invest only in the tech sector, either. Tech-sector stocks often correlate with each other as well, responding to new developments or decreased tech interest.
Sectors to consider as you build your portfolio include tech, energy, real estate, transportation, healthcare, and more. The market shocks that affect one may not affect the others. For instance, during pandemic lockdowns, transportation and hospitality companies suffered, but tech stocks soared. They hosted online meetings, provided space for people to socialize, and handled most shopping.
Another way many investors diversify is by purchasing a certain percentage of international stocks. US industries affect each other more than they affect businesses overseas. So a few international stocks or funds might be a useful hedge against market instability.
How do you keep your stock portfolio diverse when you’re not investing enough to have dozens of stocks? Most investors turn to funds. Index funds, for instance, seek to match key economic indicators through a broadly diverse stock portfolio of their own.
Diversity in Asset Classes
It’s also vital to keep your investments diverse in their risk profile. You want some high-risk, high-return investments and some stabler products. This way, if the whole market takes a dive, you’ll lose out on most of your stocks, but your bonds and bond funds will be affected much less.
As you build your portfolio, consider stocks, bonds, funds of all kinds, and alternative assets. The exact mix will depend on your risk tolerance and time horizon. If you want aggressive gains right now, knowing you have time to make up losses, you include more stocks. But people nearing retirement usually keep more bonds, because a big market downturn in their 60s could be catastrophic if their money weren’t cushioned by these low-risk products.
Some of your investments might include things like your equity in your home or owning a rental property. These assets hopefully won’t track closely with the stock market—though remember, if the whole economy plunges, even these will be affected. In that case, the best advice is to remember your time horizon. If you intend to keep your house for the next 20 years, it doesn’t matter much if it temporarily loses value.
Get a Diversification Expert
Financial advisors are experts in building a diverse portfolio and keeping it balanced over time. So, while it’s possible to do it on your own, most people prefer to hire an advisor. To find the best advisor for you, contact us today. With one quick phone call, we’ll find out what you’re looking for and match you with the perfect advisor for your needs.
