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Investing 101: The Importance of Diversifying Your Portfolio
All investments come with risk, and there's a direct relationship between the risks you take and the returns you could potentially earn on the money you're saving for retirement. That might sound scary if you're new to investing your money in the market.
But good investing takes steps to manage and mitigate unnecessary risks in your investment accounts and portfolios. Properly diversifying your assets is one of the most important risk-management strategies to use.
What Does It Mean to Diversify Your Portfolio?
There's an old saying that goes, "don't put all your eggs in one basket." In other words, don't put all your valuables in a single place, because if something happens to your one basket, you lose all of your eggs.
This exact concept applies to your investments. You don't want to hold all your money in one type of investment — all stocks, all bonds, or all of another commodity or asset class — because if something happens and the value of that particular investment drops, your entire portfolio will drop.1 In other words, you don't want to be too concentrated in a single investment type.
As Dennis Coughlin, CFP®, writes in Kiplinger, "[You] diversify — so that the failure of one 'engine' doesn't bring down the whole plane."1
Diversification protects you from unnecessary risk by spreading out your investments across the entire financial market.
How Does Diversification Protect Investors?
Diversification protects investors from unnecessary risk by spreading out your investments across the entire financial market rather than concentrating your money in one place. To properly diversify your portfolio, you need to:
- Invest in various asset classes. For example, you might put some of your money into stocks and some into bonds.
- Invest in different types or subclasses of a particular asset class. For example, when you put money into stocks, you could diversify between large cap, small cap, growth, value, domestic, international, and so on.
- Invest in different market segments. Let's say you want to invest heavily in technology when it comes to equities like stocks. That's great, but you should balance that out with investments in other sectors, such as healthcare or manufacturing. When it comes to bonds, you might want to diversify by investing in a way that allows you to hold bonds from various issuers and with different maturity dates.
Clearly, diversification presents you with a lot of options.2 The next step is knowing how much variety is enough — and what might be too much.
The Right Level of Investment Diversity
How much you need to diversify depends on your specific goals and risk tolerance. There is no one answer to what "correct" diversification looks like. But you can over-diversify, or spread your investments too thin.
Constantly adding new investments to your portfolio for no reason can make your money harder to track and manage — and it doesn't help you achieve the point of diversification, which is to better manage the risks you take to earn a reasonable return.
The "right" amount of diversification for you can be difficult to objectively measure on your own, which is why it's helpful to work with a third-party professional to help you. A qualified investment advisor can help with financial planning to identify how much risk is appropriate for you, and how diversified you need to be to reach your long-term investing goals.
Call us at 1-888-SYNOVUS (1-888-796-6887) today to see how partnering with a professional to manage your investments could make a big difference to your success.
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