What's The Best Way To Diversify Your Portfolio?

Last week, we talked about the perils of allowing your investing strategy to be impacted by your emotions. Letting your emotions dictate your investing strategy often places you in a reactive pattern that can lead you to make decisions after the market has already responded to price fluctuations- this means you’ll likely buy high and sell low. So, what should you do instead? By taking a proactive strategy and building a diversified portfolio, you’ll incur fewer losses due to market movements.

Here are some tips for building a diversified portfolio:

Spread the Love

Investing is definitely an area of your life where you don’t want to play favorites. You may have already been told that your investments should span different industries, asset classes, and geographic locations. The reason for this is that, historically speaking, it’s unlikely for these subsections of the market to move in unison. Therefore, if you share the love and spread your investments over various subsections of the market, your portfolio will be protected from major volatility. For example, if you’re invested in technology, industrials, and health care, and the healthcare sector experiences a downturn, your portfolio won’t lose all its value because you still have investments in two other sectors.

Invest in some ETFs

One easy way to diversify is to invest in ETFs (exchange traded funds). An ETF is a security that tracks an index, a commodity, bonds, or a basket of assets. Some ETFs, such as the SPDR DIA, which mirrors the Dow Jones Industrial Average, follow a benchmark index. An index is a collection of instruments that is constructed to track economic movements in a particular portion of the market.

You can utilize your equities brokerage account to invest in different asset classes through ETFs. Bond ETFs, for example, allow you to invest in bonds at a much lower cost than if you purchased the actual bonds. Bond ETFs, such the iShares IEF 7-10 Year Treasury Bond ETF, replicate various bond indices and are a cost effective way for investors to gain exposure to the asset class.

When investing in ETFs, it’s important to keep in mind that there are additional embedded costs. All ETFs have expense ratios which cover the costs of operating the fund. These costs are embedded into the price of the ETF.

Make investing a habit

If you’re going to start a proactive investing strategy that focuses on building a diversified portfolio, it’s important to make investing part of your lifestyle and commit to putting money aside regularly. By developing the habit of putting money aside for investing, you can take advantage of dollar-cost averaging in your investing strategy. This basically means that you invest a set dollar amount into your portfolio at regular time intervals (every week, month, etc.), regardless of share price. With dollar-cost averaging, you’ll buy more shares when prices are low and fewer shares when prices are high and, eventually, the average cost per share will decrease. Dollar-cost averaging lessens your investing risk because you aren’t seeking to time the market by putting all your money into an investment at a single point in time, which allows you to focus on diversification as you invest.

Brush up on your fractions

The fractional share technology on DriveWealth’s app makes it easy for investors to create a diversified portfolio on any budget. Fractional shares allow investors to put any dollar amount they want (even just $5) into any stock they want, regardless of share price. Having the ability to invest in terms of dollars will allow you to spread your money out across securities in different sectors, asset classes, and geographic locations without being constrained by high share prices.

Keep Your Investing Personality in Mind

So now you know that you should be building a diversified portfolio. But, how do you know how much money to allocate towards each asset class, industry, or location? There are many things that go into constructing an asset allocation strategy, but two things to keep in mind are your risk tolerance and your time horizon. Knowing when you need access to your money (time horizon) and how much risk you feel comfortable taking will help you figure out how to structure your portfolio. For example, if you are 58 years old and looking to retire in 2 years, you may choose to invest in less volatile investments, such as treasuries or large cap-equities. On the other hand, if you are younger and willing to take on more risk, you may invest more heavily in stocks of international companies.

Stay in the know

Even after you’ve built a diversified portfolio, it’s important to monitor your investments rather than putting them on “auto-pilot.” You don’t necessarily need to conduct in-depth analysis on all your holdings, but maintaining awareness of overall market conditions and news related to companies you are invested in will help you to maintain a diverse investment strategy.

Diversification is a key principle of investing- just like location and real estate or fine wine and dining- and there’s definitely a reason why successful investors have made it their battle cry. If you construct a diverse portfolio, you’ll be more likely to grow and maintain your wealth over time.

All investing carries risk. Past performance is not indicative of future returns, which may vary. Investments in stocks and ETFs may decline in value, potentially leading to a loss of principal. Online trading has inherent risk due to system response and access times that may be affected by various factors, including but not limited to market conditions and system performance. An investor should understand such facts before trading. The risks associated with investing in international securities, including US-listed ADRs and ETFs that contain non-US securities include, among others, country/political risk relating to the government in the home country; exchange rate risk if the country’s currency is devalued; and inflationary/purchasing power risks if the currency of the home country becomes less valuable as the general level of prices for goods and services rises.

Most inverse ETFs “reset” daily, meaning that these securities are designed to achieve their stated objectives on a daily basis. Their performance over periods longer than one day can differ significantly from the inverse of the performance of their underlying index or benchmark during the same period of time. This effect can be magnified in volatile markets, making it possible that you could suffer significant losses even if the long-term performance of the index showed a gain. While there may be strategies that justify holding these investments longer than a day, buy-and-hold investors with an intermediate or long-term time horizon should carefully consider whether these ETFs are appropriate for their portfolio.

Before investing in an ETF, an investor should consider the investment objectives, risks, charges, and expense of the investment company carefully. The prospectus contains this and other important information about the investment company. You should read the prospectus carefully before investing. Click here to obtain a copy of the prospectus.