By Bozena Pomponio
The Daily Record Newswire
When it comes to investing, putting all your eggs in one basket is not a great idea. Investors need to diversify their portfolios to protect themselves from losing a substantial portion of their assets in a down market. In order to diversify correctly, investors need to spread the risk between different asset classes such as stocks, bonds, and cash and between different sectors within each asset class.
Choosing appropriately among asset classes and sectors and creating a successful strategy depends on one's financial goals, time horizon and comfort with volatility.
To build a diversified portfolio and to reduce risk, successful investors need to incorporate different assets in their portfolio. How much you put in stocks for growth, bonds for income, and money market funds for safety and liquidity depends on time horizons for achieving your investment goals and risk tolerance. The rule of thumb to see how much money to put in stocks versus bonds is to subtract your age from 100 and put this percentage in stocks and the rest in bonds.
For example, if you are 30 years old, put 70 percent of your investments in stocks and remaining 30 percent in bonds. Traditionally, bonds have provided stability and income to portfolios.
Also, you should try to stay diversified with each type of investment. Your portfolio should consist of a variety of assets so that not all of them will be affected the same way by market events. By doing so, a potential loss on one type of investment can be offset by a gain on another.
Further diversification can be achieved by adding assets such as real estate funds, commodities, and international funds. When it comes to stocks, it is also a good idea to diversify by market capitalization (small, mid, and large caps), by geographical markets (domestic or international), and by different sectors such as technology, utilities, and energy. By spreading your assets across different parts of the stock market, you are able to reduce risk.
Likewise, when investing in bonds, one should consider different maturities, credit qualities, and durations, which are directly related to interest rates. Stocks might provide higher opportunity for growth over the long-term, but bonds provide a cushion against any unpredictable movements of the stock market, and should therefore be included in investors' portfolios.
Spreading your investments across different categories reduces the risk if there is a downturn in one category. As an example, if you invested all your money in the U.S. stock market in 2007, you would have lost more than 30% the following year. However, if your portfolio was diversified, say half in stocks and half in bonds, the loss would have been around 17 percent, not great but better than the 30 percent decrease.
No one knows which market class will be up or which will be down, so diversifying your assets gives you the best risk-adjusted return. Furthermore, a diversified portfolio has better long-term investment results and helps to insulate your portfolio from financial losses.
While diversification is a widely known topic in the world of finance, many people do not understand what it means to correctly diversify an investment portfolio.
In addition, many individuals have difficulty looking over their investments so that they are properly allocated. If you are uncertain how to diversify, contact a financial advisor who will be able to provide you with advice on diversifying your portfolio.
-----
Bozena Pomponio is an Analyst/Portfolio Manager for Karpus Investment Management, a local independent, registered investment advisor managing assets for individuals, corporations, non-profits and trustees. Offices are located at 183 Sully's Trail, Pittsford. Call 585-586-4680.
Published: Fri, May 06, 2016
