What is a diversified investment portfolio?
In a diversified investment portfolio, the assets are not correlated with each other. When the price of one rises, another may fall. This mix can reduce overall risks because no matter what the economy is doing, some asset classes will benefit. Risks are also mitigated because it’s rare for an entire portfolio to be wiped out by a single event. A diversified portfolio is your best defense against a financial crisis.
How does diversification work?
Stocks perform well when the economy is growing. Investors want the highest possible return, so they push stock prices up. They are willing to take on greater downside risk because they are optimistic about the future.
Bonds and other fixed-income securities perform well when the economy slows. Investors are concerned with protecting their holdings during downturns. They are willing to accept lower returns in exchange for reduced risks.
Commodity prices fluctuate based on supply and demand. Commodities include wheat, oil, and gold. For example, wheat prices will rise during a drought that limits supply. Oil prices will decline if there is a surplus. As a result, commodities do not follow the phases of economic cycles as closely as stocks and bonds.
Including these six asset classes in your diversified portfolio
Here are six asset classes to help you build a diversified investment portfolio:
1. U.S. Stocks: U.S. stocks represent publicly traded companies based in the United States. Companies of various sizes should be included. Company size is measured by its market capitalization, so small, mid-cap, and large-cap stocks should all be part of the portfolio. These stocks respond differently depending on the stage of the economic cycle.
2. U.S. Fixed Income: Fixed income investments pay a predetermined return according to a set schedule. This includes bonds, certificates of deposit, and money market funds.
3. Foreign Stocks: This category includes companies in both developed and emerging markets. You can achieve greater diversification by investing overseas. International investments can generate higher returns since emerging countries often grow faster. However, they are also riskier investments, as these countries typically have weaker central bank protections. They are susceptible to political changes and are less transparent.
4. Foreign Fixed Income: This category includes both corporate and government securities. They provide a hedge against a declining dollar. They are generally safer than foreign stocks.
5. Alternatives: Alternative investments can include a wide range of assets and typically make up the smallest percentage of the portfolio compared to other asset classes. Examples of alternative assets include real estate, commodities, private equity, venture capital, and derivatives or cryptocurrencies.
6. Your Primary Residence as an Asset: Financial advisors often do not consider the equity in your home to be a real estate investment. They assume you will continue to live there for the rest of your life. This approach has led many homeowners to borrow their home equity to purchase consumer goods. When housing prices fell in 2006, many homeowners owed more than the value of their homes. As a result, many people lost their homes during the financial crisis. Some walked away from their homes while others declared bankruptcy.
Diversification and Asset Allocation
How much should you own of each asset class? There is no one-size-fits-all approach to good diversified investing.
Investors use asset allocation to determine the right mix of stocks, bonds, and commodities. This depends on your comfort level with different risks, your goals, and your life situation. For example, stocks are generally riskier than bonds. If you need money in the next few years, you should own more bonds compared to someone who can wait 10 years. Thus, the proportion of each asset class depends on your personal goals. It should be developed with a financial advisor.
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Also, rebalancing according to the current phase of the economic cycle. In the early stage of the recovery process, small companies perform better. They are the ones who recognize the opportunity and respond faster than large companies. Large-cap stocks perform well in the later part of the recovery. They have more money for marketing than small companies.
When is a diversified investment fund a diversified investment?
A diversified investment fund provides more diversity than individual securities. It tracks a bundle of stocks, bonds, or commodities. But it is not a substitute for a good diversified portfolio.
A mutual fund or index fund is considered a diversified investment if it contains all six asset classes. To meet your needs, those assets should also be balanced according to your goals. Then, they will be adjusted, depending on the phase of the economic cycle.
Frequently Asked Questions
1. What is a portfolio?
In banking, a portfolio is a collection of financial assets that includes stocks, index funds, and bonds. A person can manage the portfolio themselves or hire a financial advisor to manage the portfolio on their behalf.
2. What is a diversified investment fund?
A mutual fund or exchange-traded fund is considered an alternative to investing in individual securities. It tracks a bundle of stocks, bonds, or commodities. 不是什么达夫基金
Source: https://www.thebalancemoney.com/what-is-a-diversified-investment-3305834
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