Macro Mondays: Risk & Diversification (Part 4 of 5)
Welcome to another installment of Macro Mondays here on GradMoney! We continue the discussion on risk and diversification by taking a brief look at how to answer the all important question: is my portfolio really well diversified? And if the answer is 'no,' what can I do to solve this issue?
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The most basic – and effective – strategy for minimizing risk is diversification. A well-diversified portfolio consists of different types of securities from diverse industries, with varying degrees of risk. While most investment professionals agree that diversification can’t guarantee against a loss, it is the most important component to helping you reach your long-range financial goals, while minimizing your risk.
Am I Sufficiently Diversified?
There are several ways to ensure you are adequately diversified, including:
Spread your portfolio among many different investment vehicles – including cash, stocks, bonds, mutual funds, ETFs and other funds. Look for assets whose returns haven’t historically moved in the same direction and to the same degree. That way, if part of your portfolio is declining, the rest may still be growing. (See also: Bond Basics.)
Stay diversified within each type of investment. Include securities that vary by sector, industry, region and market capitalization. It’s also a good idea to mix styles too, such as growth, income and value. The same goes for bonds: consider varying maturities, credit qualities and durations.
Include securities that vary in risk. You're not restricted to picking only blue-chip stocks. In fact, the opposite is true. Picking different investments with different rates of return will ensure that large gains offset losses in other areas.
Keep in mind that portfolio diversification is not a one-time task. Plan on performing regular “check-ups” or rebalancing to make sure your portfolio has a risk level that’s consistent with your financial strategy and goals. In many cases, for example, investors will taper off riskier investments and stack up on “safe” investments after they retire.
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