Risk Management 101: Diversifying Your Portfolio
When it comes to investment portfolios, strategists will always recommend one simple strategy: diversification. Diversification means spreading your investments across different types of asset classes in order to decrease volatility, since each asset class possesses its own unique risks. The main asset classes include stocks, bonds, and cash equivalents, but also include things like cryptocurrencies and real estate. You can even diversify within these classes, choosing both foreign and domestic markets for your stock investments, for example. Investopedia recommends a portfolio of 25 to 30 stocks as one way to reduce risks.
According to Fidelity, there are 4 components of a diversified portfolio that you should aim for: domestic stocks, bonds, short-term investments, and international stocks. By investing in these different types of assets, you have varying levels of risk, return, and growth in your portfolio. In theory, this strategy helps balance the gains and losses of your investments; so, if one investment performs poorly, it will be neutralized by an investment that performs well.
Though there are lots of specific considerations to be made when building your portfolio, the two that are commonly prioritized are time and risk tolerance. Most people use their retirement date as the time horizon for their investments; this is when they will ultimately need the money, so depending on the time they have until that date, they can choose the level of risk they’re willing to take. This threshold for risk is called risk tolerance, which will inevitably change depending on the time that has elapsed, but is also determined by your personal finances.
Clearly, a lot goes into cultivating a diverse portfolio that works for you, but it can be made easier with the number of financial tools available nowadays. Robo-advisors or regular investment advisors are highly recommended for helping you determine the exact strategy you should use for diversifying your portfolio. CNBC Select recommends robo-advisors like Betterment, Wealthfront, Charles Schwab, Ellevest, and SoFi Invest®. Diversification can be time-intensive, but it is an important aspect of risk management that, when done carefully, can be very rewarding in the long-term.
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