Why You Should Build a Diverse Investment Portfolio
posted Apr 15, 2019 by Guest Post from KLR Wealth Management, David Wray, CFA in the Business Blog
We all know the expression “Don’t put all your eggs in one basket,” and that is especially relevant when it comes to investments. A well-diversified portfolio is crucial in every market environment because different component parts often respond differently to changing events. This has the effect of reducing aggregate portfolio risk without reducing long-term returns. This is truly the one and only ‘free lunch’ available to investors.
What exactly is diversification of investments?
Diversification is a risk management strategy in which an investor utilizes all available asset classes (stocks-bonds-cash) and a wide variety of asset sub-classes (such as U.S. Large Cap, Emerging Markets, Real Estate Investment Trust, or REITs, etc.).
For a simplified example: You have a portfolio comprised of only suntan lotion stocks and rain is in the forecast. By adding in umbrella stocks, your portfolio is able to withstand the downside volatility from the reduction in suntan lotion products.
How do you get started with diversification?
The right wealth management advisor will help secure your financial future every step of the way, and make sure your portfolio is well diversified.
Some things to keep in mind…
Effective diversification depends on diversifying your investment portfolio across the board – among and within all major asset classes.
- When beginning with a large sum of cash – diversify your entry across multiple time periods. Dollar-cost averaging, whereby the process of adding funds is made at periodic intervals, can be a very effective strategy.
- What about active vs. passive management? – With an active investment fund, a manager or a management team makes decisions about how to invest the fund's money. By contrast, a passively managed fund is constructed to follow a market index. It does not have a management team making investment decisions.
While an investor can choose to diversify using strategies representing both types of management in all asset classes, it is important to diversify among individual asset managers to avoid the tendency for strictly one process and one bias to dominate portfolio construction. For example, a passive S&P 500 index fund can be used for U.S. Large Cap, complemented by active managers within less-efficient equity sub-classes such as U.S. Small Cap and Emerging Markets.
*Large cap refers to a company with a market capitalization value of more than $10 billion. Small cap, on the other hand refers to a company with a market capitalization value ranging between $300 million and $2 billion.
The guiding directive for building a diversified investment portfolio must always be in keeping with your very individualized long-term wealth objectives. Let us help you build your portfolio today! Contact KLR Wealth Management, LLC.