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How many times have you heard someone say, "don't put all your eggs in
one basket?" When it comes to investing, that old saying is very good
advice. Successful investors know that diversifying their investments can
help reduce the impact that a single, poorly performing investment can
make on your overall portfolio, or mix of investments.
Diversification means more than having different kinds of investments,
such as stocks, bonds and mutual funds. It means having a mix of
investments in different sectors or industries. A well-diversified
portfolio might include bonds, money market funds, stocks of small,
medium, and large companies in a variety of industries and countries and
mutual funds which offer different levels of risk. Even if your risk
tolerance is low, you can still consider diversifying into riskier
investments as long as you keep the overall risk of your portfolio low.
Determining Your Investment Mix
An important first step in building a well-diversified investment
portfolio is deciding how to divide your money among various investments.
These types of investments can include individual stocks and bonds,
mutual funds that invest in stocks or bonds, bank accounts and money
market mutual funds.
Financial professionals such as stockbrokers, financial planners and
insurance agents can help you analyze your financial needs and
objectives. They can recommend a mix of appropriate investments. In
addition, mutual fund organizations may use their own sales forces or
outside professionals to help potential investors. If you prefer to do it
yourself, researching stocks and mutual funds and buying shares can be
accomplished through the mail, over the telephone, or on the Internet.
It's not as complicated as you might think.
To help you determine the mix of investment options that may be
appropriate for your investment goals, ask yourself the following
questions:
- What are my investment goals?
- What is my time frame to reach these goals?
- Can I afford to invest regularly?
- What growth rate do I need to reach my goals?
- What is my risk tolerance to reach my investment goals?
Diversification is essential for successful investors who have
multiple goals with different time horizons. For example, if you were
saving for both a car and retirement, you would likely consider different
types of investments for each goal. Similarly, a 30-year-old unmarried
investor is likely to need a different investment mix than a 50-year-old
with two children heading off to college in the next few years. If you
are retired, protecting your principal becomes increasingly important as
opposed to growing the investment.
Maintaining a Diversified Portfolio
It's a good idea to periodically review your investment plan. Because
different investments grow at different rates, your current distribution
of money among stock, bonds, and money market funds may no longer
correspond with your original distribution. If this happens with your
investments, you will probably need to redistribute some money to bring
your investment mix back in line with your original plan.
In addition to the annual review, whenever you make a major life
change, it's time to reassess your overall financial situation. Some
common examples of such changes include switching careers, retiring,
getting married or divorced, having a child, starting your own business,
taking care of an elderly parent, and entering college or paying tuition
for a child. Most of these events are likely to affect your ability to
invest, your time horizon, and your overall financial picture, both
short-term and long-term.
It's never easy to find the time to review your investment plan when
you're in the midst of any of these life changes. But it's worth making
the effort. You don't want to enter a new phase of your life with a
financial plan that was designed for different circumstances.
In the end, staying on course with a diversified investment mix will
help make sure that the performance and risk levels of your overall
portfolio reflect your goals and expectations.
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