4 Best Ways to Diversify Your Portfolio and Reduce Risk

There is no secret to investing. All of the information is out there for you to go and find and make better investment choice.

Everyone makes mistakes.

Even billionaire make bets that do not work out. Warren Buffet has made plenty of deals that did not work out the way he anticipated.

But you are not Warren Buffett or some billionaire. You are an individual that cannot afford to make big mistakes. That cannot afford to lost $1,000,000 or even $1,000. That could be a child’s college tuition or a year or two off your retirement.

You want to make the best investment choices possible and reduce your risk as much as possible.

There is not magic investment that does not include risk. U.S. government bonds are very safe investments, but there is risk that the government goes bankrupt and cannot pay its debts. But that risk is so small.

Generally, when an investment has little or no risk the return is not as great as an investment with a lot of risk.

Bonds are less risky than stocks and stocks have a much greater potential for returns than bonds.

The government is more stable than corporations. Corporations can go bankrupt. The government can be bailed out by the American taxpayer. So corporate bonds are more risky than government bonds and pay more in interest. I mean really bonds don’t pay you a lot, but they are reliable. They pay you every year the amount agreed to.

So in order to reduce your risk, but still get some decent gains in your portfolio you need to have a mix.

You need to diversify. But what really does diversification mean? It means not putting all your eggs in one basket.

There are 4 ways to diversity your investment portfolio that will reduce your risk as much as possilble, but still allow you to take advantage of investment gains.

4 Ways to Diversify:

  1. Diversify assets classes – Stock, bonds or commodities.
  2. Diversify withing asset classes – Invest in different types of bonds. or stocks. or commodities.
  3. Diversify across markets – U.S. or international. When one market is doing poorly the other market may be doing great. Europe may be slumping while Asia is rising.
  4. Diversify across time – invest at recurring times each month, quarter or year. Dollar cost averaging will allow you to buy when the market is up or down.

I have already mentioned that bonds are less risky than equities. So you should hold more bonds than stocks.

Commodities often move in price independent from stocks. So investing in gold or oil can offset movements in the market.

Gold often increases in value when the market is decreasing. So you should hold more bonds than stocks.

But maybe you are young and can afford to take more risk. Can you can put more of your portfolio into stocks. As you get older you should sell some stocks in favor of safer bets in fixed income assets.

My favorite topic is dividends, but index funds are my next favorite.

Index funds are your way of diversifying within asset classes. When you purchase a share of an index fund you are entitled to a portion of the underlying assets. And in those assets include a wide variety of assets in the market.

An index fund follows a certain section of the market. Like the tech sector, RETIS or dividend appreciation.

These funds can hold positions in hundreds of stocks. So the risk is spread out among lots of different assets. Now since they hold positions in lots of equities these funds are susceptible to systemic risk.

If the entire market goes down so do these funds.

Why does diversification matter?

It is all about emotion. Invest in the market is emotional. We get a bad feeling watching our investments drop. But it does not have to be that way. When investments drop that is the time to buy.

They will not stay low forever.

When an asset drop everything goes on sale and thats when you strike.

Before you make a single investment you should have a plan. Do not get me wrong, I have made a plan and then had to change it slowly over time as I learned more and better information.

You do not have to stay stuck just because you have a plan and it is not working for you anymore. There is always a solution. But the best returns happen when you create a plan and then stick to it over the long term.

Rebalancing

This is crucial. Now that you are diversified you need to stay that way. If you purchase assets at one moment in time and let them run free then you portfolio percentages will get out of whack you assets will outpace your bonds or vice versa.

Every so often you need to rebalance: Sell some stocks and put that money into your bond bucket to make it even again.

This is essential because when the stock market drops gold increases you will want to sell some gold in order to purchase stocks. That way everything feeds one another. And you are always protected.

No one cares about your portfolio as much as you do. Do not make a decision that you do not understand.

Ask questions.

Do research.

Learn about where your money is going. It is better to do nothing than make a decision that is not in your best interest.

What are your thoughts? Leave a comment. I read them all.

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Published by Collin Harness

Obsessed with creating value and helping people achieve financial independence.

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