Everyone has heard the common phrase "Don't put all of your eggs in one basket." Nothing could be truer when it comes to investing. The tough part for most investors is just learning what the different areas there are to diversify over.
Everyone has heard the common phrase “Don’t put all of your eggs in one basket.” Nothing could be truer when it comes to investing. The tough part for most investors is just learning what the different areas there are to diversify over.
Most people know that stocks, bonds and cash are typical instruments that are available to invest in, but true portfolio diversification must be thought through for many layers beyond that.
Here are a few main considerations to have in mind for a well-diversified portfolio:
Invest in many different companies
Having too much weight of a portfolio in one company is a large mistake. Just ask the folks with large positions in Enron or Lehman Brothers. Where people get trapped in this is when their retirement plan is matched with company stock or when a sizeable amount of their compensation is in company stock options.
If this ends up being the case, familiarize yourself with when you can sell these options and purchase other investment options.
Be aware of the size (capital) of companies
Companies will generally be referred to as “large cap” — companies valued at $10 billion-plus (some in the investment world categorize companies at $200 billion-plus as “mega cap) — “mid cap” — companies valued between $1 billion and $10 billion — and “small cap” — companies valued below $1 billion.
In general, the small cap space should be expected to be more volatile and have more failure … but with this comes larger upside potential. Larger companies tend to be more reliable and have relatively slower and steadier growth while paying dividends along the way.
The allocation suited to your needs really depends on your objectives, time horizon and risk tolerance. But generally growth portfolios will be more heavily weighted in equities. More conservative portfolios are generally more heavily weighted in fixed income.
By sector of the economy
Spread your dollars over many different areas of the economy. This helps your portfolio from being decimated when “bubbles” burst. (In most recent memory we can all recall the losses of the tech, real estate and financial bubbles.)
The general different sectors of the economy to be considered are: Basic Materials, Financial Services, Real Estate, Utilities, Health Care, Communication Services, Energy, Industrials and Technology.
“Growth” vs. “Value”
Almost all equity investments fit into one of these two categories (or are considered a blend of the two). Growth-oriented investors generally look for companies that have the potential to grow at faster rates relative to other companies, because they reinvest their profits back into their business. Growth companies are generally trending higher and have good potential to continue to do so over a long-term time horizon.
Value investing is more academic. Value-oriented investors are much more concerned with getting a stock as a bargain or at a good value. Value investors focus on certain valuation metrics that basically come back to the old “buy low, sell high” motto.
However, when the S&P 500 is dissected by growth and value, both categories of companies make up the annual return of this commonly tracked benchmark. So for a long-term portfolio, it should be considered to have mix of growth and value investment.
Diversify by geography
Although with tighter regulations, governance and opportunity, U.S. companies are a good spot for the majority of your investments, but spreading your international portion over Europe, Asia and elsewhere is key as well. Just because you have an international element to your portfolio does not mean it is truly invested all around the globe. Although very volatile and unpredictable, emerging market investments have a small place in a long-term portfolio as well.
Of course with these are just general thoughts and guidelines when it comes to building the equity portion of a portfolio, and individual circumstances such as age, risk tolerance, time horizon, etc., will dictate the percentages to each above.
Jon C. Ylinen is a Financial Advisor with North Star Resource Group and offers securities and investment advisory services through CRI Securities, LLC. and Securian Financial Services, Inc., Members FINRA/SIPC. CRI Securities, LLC. is affiliated with Securian Financial Services, Inc. and North Star Resource Group. North Star Resource group is not affiliated with Securian Financial Services, Inc. but is independently owned and operated. The answers provided are general in nature and are not intended to be specific recommendations. Please consult a financial professional for specific advice in relation to your individual circumstances. This should not be considered as tax or legal advice. Please consult a tax or legal professional for information regarding your specific situation. 606534/ DOFU 1-2013
Diversification and asset allocation are methods used to manage risk. They do not guarantee against loss. Investments will fluctuate and when redeemed may be worth more or less than originally invested. Investments in small, mid or micro cap companies involve greater risks not associated with investing in more established companies, such as business risk, stock price fluctuations, increased sensitivity to changing economic conditions, less certain growth prospects and illiquidity. Investment risks associated with international investing, in addition to other risks, generally will include currency fluctuations, political, social and economic instability and differences in accounting standards when investing in foreign markets. Investments in emerging markets involve heightened risks due to their smaller size, decreased liquidity and exposure to political turmoil or rapid changes in economic conditions not normally experienced by more developed countries. The S&P 500® Index is a commonly recognized, market capitalization weighted index of 500 widely held equity securities, designed to measure broad U.S. equity performance. You cannot invest directly in an index.