You’ve heard the old investment adage, “Don’t put all your eggs in one basket.” It’s good advice. A diversified portfolio should be at the core of any well-planned investment strategy. While a worthy goal at any age, it’s especially desirable as your net worth grows over the years.
The basic purpose of diversification is to reduce your risk of loss. It’s primarily a defensive type of investment policy. Depending on your investment goals and tolerance for risk, your strategy may emphasize one type of investment over another. But overall, your plan should be diversified. That’s because no single type of investment performs best under all economic conditions. A diversified program is capable of weathering varying economic cycles and improving the trade-off between risk of loss and expected return. Of course, diversification cannot entirely eliminate the risk of investment losses.
* Diversification may help reduce, but cannot eliminate, risk of investment losses. Historical performance relative to risk and return points to, but does not guarantee, the same relationship for future performance. There is no assurance that by assuming more risk, you are guaranteed to achieve better results.
Forms of Diversification. An investment portfolio consisting of twenty different construction industry stocks is not diversified. Diversification means dividing your funds among different asset classes, such as stocks, bonds, real estate and savings accounts. For instance, suppose your portfolio consisted entirely of bonds. Your money would be at significant risk if interest rates rose since bond prices generally fall when rates go up.
It’s also important to diversify by owning several stocks in different industries. Suppose you held just 1,000 shares of a major company’s stock and during the last recession you suffered a loss of $40 per share when the stock fell from 100 to 60. A diversified portfolio consisting of many different stocks in various sectors may have cushioned the blow of the loss.
Diversification also means not tying up all your funds in long-term investments. You’ll need to keep a certain amount easily accessible — that is, in money-market accounts, savings accounts or short-term certificates of deposit (CDs) — for on-going expenses, emergency needs, and short-term goals such as saving to buy a car or pay taxes. And through dollar-cost averaging, a process of buying stocks and bonds from time to time instead of all at once, you can spread the risk over both good and bad markets. Using dollar cost averaging does not assure a profit and does not protect against loss in a declining market. Using this investment method involves continuous investment in securities regardless of fluctuating price levels of securities. Therefore, investors should consider their financial ability to continue purchasing through periods of low price levels.
Sample Portfolio. Your specific investment decisions will depend on several factors: your age, tax bracket, risk tolerance, liquidity needs, investment time horizon and investment goals. In general, however, a well-diversified portfolio might include:
- Cash Reserves for short-term needs — checking accounts, money-market accounts, savings accounts and shorter-term CDs.
- Longer-term, taxable investments that are relatively liquid, such as:
- Stocks — common or preferred
- Bonds — U.S. Government, corporate
- Mutual Funds — bond funds, growth funds, balanced funds, international funds
- Tax-advantaged investments, such as:
- Annuities — fixed and variable
- Qualified Plans — 401(k), 403(b), IRAs, SEPs
- Municipal bond funds
- Real estate — commercial, residential
You may want to consult a financial advisor regarding designing a portfolio that is appropriate for you and your risk tolerance.
Diversify Beyond Investments. Diversification alone may not be sufficient to protect your investments. By taking a broader view, a financial planning strategy can put safeguards in place to help protect yourself and your family.
For instance, purchasing disability income insurance provides protection for your ability to earn a living. Life insurance is another form of protection. It can help preserve your estate assets and reduce the risk that a disaster could wipe out your family’s standard of living. Life insurance can also provide the necessary cash for your survivors to pay estate taxes and other expenses, or to carry on a family-owned business.
A diversified financial planning strategy will not eliminate risk or guarantee success. But it can offer a sound approach to help accumulate, preserve and protect your assets, reduce risk and potentially grow assets over time. Talk with a qualified professional about how to put an effective financial planning strategy in place.
Elizabeth Paal Goss is a Registered Representative of Lincoln Financial Advisors. Securities and investment advisory services offered through Lincoln Financial Advisors Corp., a broker/dealer (Member SIPC) and registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies. 307 International Circle, Suite 390, Hunt Valley, MD 21030.Heritage Financial Consultants, LLC is not an affiliate of Lincoln Financial Advisors Corp. CRN-3098153-052220