Have you heard the term ‘diversification’ in the investment industry and wondered what it means or why it is important? More than 53 percent of Americans say they own stocks or bonds as investments.
Even though someone buys shares in a company or bonds to fund a government project, they may not have a good sense of what it means to be truly diversified.
Read on to learn about the financial benefits of portfolio diversification!
Understanding What Diversification Means
Diversifying means having a range of investments suitable for your style and needs. For example, the general rule is that you subtract your age from one to determine the breakdown of stocks and fixed income instruments you should have at a given age.
If you are 60 years old, the general rule says you should keep 40 percent of your financial assets in less risky business ventures. The other 60 percent of your investments can be in higher-risk items such as stocks.
Learning Why Diversification Matters to You
Investment portfolio diversification allows you to benefit from owning a wide range of different investments. It also gives you the chance to reduce some of the risks inherent with investing.
Being diversified will help you weather the storm during volatile markets where stocks are moving up and down regularly. Instead of taking big swings up or down, diversification will help you to avoid both extremes for a more balanced approach.
You can learn more about premium bonds as a way to diversify your portfolio and reduce your risk overall!
How to Know What to Buy
Now that you know that you should be diverse, how do you know the investments to buy to reach this goal? There is more to it than subtracting your age from one to determine the breakdown of stocks to bonds. You also need to understand your time horizon and your risk tolerance.
Your time horizon is the timeframe within which you believe you will need to use the investments in your portfolio. To decide on the appropriate time horizon, you need to consider where you are in life and what you expect in the future.
When will you retire? What is your life expectancy? What other expenses will you have in the future?
The answers to these questions will help you understand your time horizon before you start building your portfolio.
Your risk tolerance is a measure of the level of risk you are willing to take to earn a profit. The general rule of thumb is that the higher the perceived level of risk, the higher the potential is for a profit.
The Importance of Portfolio Diversification
A smart investor understands that their finances can be greatly diminished if they do not invest their money wisely with portfolio diversification. By taking time to learn about personal finance and the basics of investing, you can be more confident in the decisions you make now and into the future.
Are you looking for other great ways to continue building a nest egg for you and your loved ones? Check out our blog section for posts that include emerging trends in the stock market!