You’re probably no stranger to the old saying, “There’s strength in diversification.”
It’s true for many things, but it’s perhaps most relevant when it comes to your investment portfolio. Diversification is key for several reasons when it comes to managing your personal wealth, but it’s perhaps most important as it pertains to mitigating risk during economic uncertainty. Different types of investments and different asset classes perform differently in various conditions, a key strategy that can help mitigate loss and maintain your wealth when the going gets tough.
From stocks and bonds to mutual funds and ETFs, portfolio diversification is widely regarded as a smart investment strategy. But there are key principles and strategies that investors should take note of when it comes to their portfolio management. In this post, we’ll discuss some of these key principles that can help you successfully diversify your portfolio to grow your wealth during periods of economic growth and adequately preserve it during periods of uncertainty. Read on to learn more:
Portfolio Diversification Defined
Let’s start by discussing just what portfolio diversity is so you can understand its importance when it comes to your personal wealth. Portfolio diversification is the practice of diversifying your assets to build wealth and minimize risk. In other words, it’s the opposite of putting all of your eggs in one basket, metaphorically speaking.
Fail to diversify your portfolio, and you could end up with significant financial losses during periods of market uncertainty. However, if your assets are spread out and diversified, you’re likely to manage risk much more effectively. Yes, there might be some losses sustained, but any losses are likely to be much less significant compared to if all of your investments were in one singular place or market, rather than spread around.
Nobody can predict the future. If you could, there would be no need to diversify. But by diversifying, you’re better able to protect your assets from the inevitable ebbs and flows that occur over time.
Key Principles for Affluent Investors
So what are some of the factors that you should keep in mind when it comes to investing and diversifying your portfolio? Here’s a look at some key principles:
Think Beyond the 60/40 Rule
A concept largely born in the 1950s, the 60/40 rule is typically defined as a portfolio that consists of 60 percent of equities and 40 percent fixed income. The thinking behind this concept is that there’s usually an inverted relationship between stocks and bonds. That is when bonds are booming, stocks are down—and vice versa. However, this hasn’t exactly been the case recently. In 2022, the average 60/40 portfolio recorded its worst return at -17 percent in nearly 100 years. Instead of stocks and bonds maintaining that inverted relationship, as has often been the case historically, they’re now working more in tandem with each other.
Hence, a rebalanced 60/40 portfolio is now gaining more traction, thanks to greater diversification. For instance, the 60 might include a mix of public stocks, private infrastructure and private real estate, while the 40 might include a split of traditional bonds and private credit. This revamped 60/40 strategy offers inflation protection, better stability and interest rate control compared to the conventional 60/40 strategy.
Think Global
There are a lot of investment options available today, but don’t just think domestically—think globally. When you think of your investment strategy as a global one, you can also think of the bigger picture and explore opportunities beyond your nation’s borders. Consider looking into funds in emerging markets or in countries that are growing at a faster rate than those in North America. What’s more, investing more globally can also help protect your wealth from any current domestic events or turmoil that could send markets into a tailspin.
Make Sure You’re Periodically Rebalancing Your Portfolio
Your investment strategy shouldn’t be something that sits static and never evolves—make sure you’re rebalancing it regularly and appropriately weighing each investment accordingly. For example, it’s only natural to want to allocate more assets to strong performers and limit your investments to weak performers, all while maintaining a diverse portfolio. How often should you be rebalancing your portfolio? It’s often suggested that you reassess things at least twice a year.
Cash is King
You’ve heard the old saying that cash is king. And while cash does have some negatives—for instance, it’s bound to lose value over time due to inflation—it does provide some security and protection when markets are slumping. In fact, if you have cash in your portfolio, it’s much more likely that you’ll be able to maintain your wealth and see less of an overall portfolio decline during a market downturn. Make sure that you’re holding some cash in your portfolio—and not only for security purposes. Having cash on hand can also position you to invest further in the market in times of prosperity.
Don’t Over-Diversify
Yes, overdiversification is a thing—and it’s something that you’ll want to avoid. While diversification is generally good, make sure that any efforts to diversify your portfolio are done in a way that adds value. Overdiversification can also lead to overlapping investments, which is a big no-no. The best diversification strategy is assets that move in opposite directions from each other. This helps mitigate risk and creates a well-balanced overall portfolio.
Consider Working With a Financial Advisor Today
If you’re looking to further diversify your assets or just need help properly managing your portfolio, one of the best things you can do is work with a qualified financial advisor on your wealth management strategies. A good financial advisor has a clear and thorough understanding of the market, its ebbs and flows, and how you can best protect your wealth while also enacting strategies to grow your portfolio. A good financial advisor can also help you avoid some of the pain points involved in diversification and ensure your assets are properly managed.