Diversify, Diversify, Diversify
By Bigg Success Staff
09-26-08
Bigg Success with Money
One of the most important tenets of investing is to diversify, diversify, diversify. However, it’s a principle that’s been around for a long time – remember “don’t put all your eggs in one basket?”
By diversifying, we earn the greatest return over time with the least volatility. There are three ways to diversify your portfolio:
#1 – Diversify across asset classes
Your portfolio should include a variety of stocks, bonds, cash, real estate and more. A rule of thumb is to subtract your age from 120 to determine how much of your money should be invested in stocks (or more likely, stock mutual funds). Most of the rest should go into bonds (or bond mutual funds).
#2 – Diversify within asset classes
Within each of these asset classes, you also want to diversify. For example, you don’t want to own a single stock, or even just stocks in a single industry. You don’t even want to just own domestic stocks. Own multiple stocks in multiple industries in multiple countries.
#3 – Diversify over time
There’s one thing that’s certain about the market – it will go up and down. By investing some amount of money at regular intervals (e.g. with every paycheck), you diversify over time. This principle is known as dollar-cost averaging.
When the market is up, you’ll buy less of the same than when it’s down. So you’re buying less when prices are high and more when prices are low. Doesn’t that make sense? Isn’t that what you would like to do with anything else you purchase frequently?
Two simple solutions
One relatively easy way to diversify is through mutual funds. Pick no-load funds with low annual expenses and good performance. Diversify between stock funds and bond funds. Pick domestic funds and international funds. Then re-balance every year to keep your assets allocated properly.
An even easier way to do this is to pick a no-load mutual fund with a targeted retirement date. Then let them do all the rest. The downside is you may get a little better performance by selecting funds from more than one fund family. The upside is you have pros constantly watching over your portfolio. All you have to do is watch over the pros!
Diversification smooths out performance. When stocks go down, bonds often go up and vice versa. So you get the best possible returns without the volatility of a single class of financial assets.
