What are the benefits of Diversifying my Investments?
Diversification is one of the cornerstones of traditional investment advice. A common saying we often hear is “never put all your eggs in one basket” and when investing that line particularly holds true. Markets go up and down through economic change, business cycles, and a wide variety of other factors. Individual companies as well are impacted by these and more. One defense against risks in any investment strategy is a diverse portfolio backed by individual financial planning.
The most basic form of a diversified investment strategy is a mix of stocks and bonds. Generally, those two asset classes will perform differently depending on the market conditions of the day. Stocks often perform well when the economy is growing, unemployment is low, and consumers are confident when they reach for their wallets. Low interest rates help to generate stock market gains because many companies borrow to further invest in their businesses.
On the other hand, high quality bonds typically perform better in times of trouble. Bondholders have better protection against downturns in the market — they get paid out first in bankruptcy or corporate restructuring. But returns from bonds, if held to maturity, are limited to the interest you are paid. The last investors to get paid in a bankruptcy are the stockholders, but they benefit from the upside of dividend growth, increased stock value, etc. Bonds tend to be “safer” than stocks for many reasons, but they are more likely to keep your portfolio in better shape if the company, industry, or economy struggles. If the market is heading for trouble, you may prefer to be in the highest quality bonds (including government bonds), rather than stocks.
While it’s tempting to just own stocks in good times and bonds in bad times, it’s not always easy to predict the market. By holding a mix of stock and bonds, you can hedge your bets while earning income from your investments. The right mix of stocks and bonds (and exactly what to buy in these asset classes) is up to you and your advisor to decide.
The spectrum of investment choices available is very broad, and it’s nearly impossible to have a “perfectly-diversified” portfolio. In addition, diversified portfolios should include more than just a mix of asset classes. It’s important to diversify across countries, industries, size, management style, and investment alternatives. The idea is to have a wide variety of investments that will not react the same to the same conditions at the same time.
Your advisor needs to understand your unique situation to provide the best possible diversification advice for you and your family. Diversification is one of the most proven investment strategies to generate returns with less risk. It pays to be patient and let diversity protect your investment portfolio over the long haul.