Diversification is a fundamental concept that Millennial investors need to understand in order to successfully and safely grow their portfolios. However, it’s not necessarily a cut-and-dried topic. There are many opinions on what perfect diversification looks like, while the honest answer is that nobody knows for sure. With that in mind, it can be helpful to understand the basics.
The Need for Diversification
The goal of diversification is to spread your money around so that you don’t lose all of your assets in a single market collapse. The more investments you have in different markets and mediums, the less likely that you’ll lose everything.
If you want an example of why diversification is important, just look at the stock market collapse of 2009. For those who had all of their assets in Wall Street, these were scary times. Diversification doesn’t prevent you from losing money, but it does help you avoid disaster.
Five Options and Things to Think About
When it comes to diversification, there are many different schools of thought. Let’s take a look at some of the options you have and a few tips worth considering.
1. Look Past Obvious Investments
The first key to successful diversification is looking past the obvious investments in stocks and bonds. While you should certainly have a healthy percentage of your portfolio attached to these investments, you also need to pursue alternative options in order to safeguard against risks.
One great way to balance out a stock-heavy portfolio is to invest in futures. When you invest in futures, you’re able to control large dollar amounts of a commodity with relatively small amounts of capital. This makes it ideal for investors who are limited by a relatively small portfolio.
2. Variety, Not Quantity
It’s important that you have different kinds of investments. In other words, you need investments that do different things. As Kathy Kristof of Nolo points out:
- Stocks grow your portfolio over time.
- Bonds actually bring in recurring income.
- Real estate provides a hedge against inflation and may rise when stocks fall.
- International investments keep your portfolio afloat when the American economy suffers.
- Cash gives you security and liquidity.
While you need not invest in all of these categories, it’s smart to diversify your portfolio with at least three or four of them. And remember, it’s not about the quantity. Just because you can’t put $100,000 in stocks, $100,000 in bonds, $500,000 in real estate, etc. doesn’t mean you shouldn’t diversify. It’s all about your individual portfolio. Think about diversification in terms of percentages, not dollar signs and decimal points.
3. Avoid Autopilot
While many investments – such as retirement accounts and mutual funds – are largely considered hands-off, avoid the temptation to put your portfolio on autopilot. Don’t flinch at the first sign of trouble, but do understand when the time is right to get out. Always remain in tune with the market and reach out to industry experts for guidance.
4. Invest Over Time
Lump sum investing isn’t always the smartest idea. Instead, consider spreading out your investments and contributions over time. This evens out the changes in market peaks and valleys, which can hurt your portfolio.
For example, if you have $5,000 to invest, it may be wise to invest $2,500 now, $1,500 in six months, and $1,000 in eight months. This diminishes your chance of making a poor investment.
5. Be Aware of Commissions
It’s important that you understand how your money is being spent. One key aspect of investing is keeping a watchful eye on commissions. If your investments are largely automated, it’s likely you’re paying someone to make decisions for you. Do you know how much you’re paying them? Where are they taking the money from? How often do you pay them? Answers to questions like these are very important.
Start Diversifying Sooner Rather Than Later
As a Millennial investor, you must remember that you have plenty of time before retirement. In most cases, you have 25 to 40 years before retirement is even an option. You still need to begin investing and diversifying now, though. With that being said, you have more time to recover from market downturns. There is such a thing as too much diversification, but you should be willing to take some risks.
“It’s important to keep in mind that you’ll have a long time in retirement,” says Joe Ready, head of Wells Fargo Institutional Retirement and Trust. “You have to manage risk but you also have to have a reasonable exposure to it. If you get too conservative, inflation and overall [market changes] over time may erode your purchasing power if you’re not adequately diversified.”
Think about the tips, options, and strategies noted in this article. There is no concrete formula for proper diversification. The key is to lower your risk without compromising your ability to grow your portfolio. Keep this in mind and make educated decisions moving forward.