One of the most basic principles of pursuing the growth of long-term wealth is diversification. A diversified approach to building wealth helps to mitigate risk while capturing the benefits of rising markets. Why is it so important to spread risk around?
Diversification’s Long-Term Value
If you invest too heavily into just one part of the economy, you are at risk of losing a lot of money if a specific industry or sector falls apart. One recent example of this happened in 2007-2008 when real estate prices fell, and people defaulted on mortgages.
The value of a diversified portfolio can manifest itself over time. Many investors struggle to realize the benefits of their investment strategy because, in buoyant markets, people tend to chase performance and purchase higher-risk investments; and in a market downturn, they tend to flock to lower-risk investment options; behaviors that can lead to missed opportunities.
Diversification is Not a One-Time Task
Once you have a target asset mix based on your time horizon and risk tolerance, you need to periodically continue diversification through rebalancing your portfolio. But how often do you rebalance your portfolios? Many investors don't rebalance at all. The reason why investors aren't rebalancing is because they think diversifying is a one-time task. They believe that once they've selected their target asset mix, they're done. However, this isn't true. You still need to rebalance periodically to help ensure that your portfolio stays consistent. Otherwise, your portfolio could potentially become too risky or too conservative. Why does rebalancing matter? Because it keeps your portfolio consistent with your investment objectives and goals. If you want to pursue maximizing your returns and building wealth over a long period of time, you'll want to maintain a balance.
Diversify Across Asset Classes
Diversifying across asset classes means investing in the stocks and bonds of many companies and governments with no or low correlation among each other, not just a few; this is valuable because an individual company, or even a handful, is likely to experience much greater volatility in value than a larger group of companies may. To be diversified across asset classes, consider refraining from investing a lot of your portfolio into any one stock. Instead of investing your money in a single stock or bond, consider investing your money into a group of stocks.
Diversifying Across Time
It's best to invest as early in your career as you can to allow for greater returns and to help increase the benefit of compounding interest. In an ideal world, you would invest a large sum of money as soon as possible and leave it invested for a very long time, however, this isn't consistent for most people, and you may need to work through several financial decisions (buying a house or paying off student debt) before investing any money anyway. Also, investing all at once often causes anxiety because no one can predict exactly what the market may do next. It is important to spread investment dollars out evenly throughout the year. One method of doing this is called dollar cost averaging, where one invests a certain amount each month. Another option is to invest a fixed percentage of one's portfolio every quarter, such as 10% per quarter. Regardless of the method used, the goal is to invest regularly and consistently, rather than waiting until the last minute to buy shares. This allows for greater returns over time and avoids the risk of missing out on great opportunities due to poor timing.
Contact the office today to learn more about the use of diversification in your long-term wealth strategies.
This material was developed and prepared by a third party for use by your Registered Representative. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security. The content is developed from sources believed to be providing accurate information.
For advice regarding your specific circumstances, the services of an appropriate legal or tax advisor should be sought.
A diversified portfolio does not assure a profit or protect against loss in a declining market.
Rebalancing may be a taxable event. Before you take any specific action be sure to consult with your tax professional.
Dollar cost averaging will not guarantee a profit or protect you from loss but may reduce your average cost per share in a fluctuating market.