How to Create a Diversified Portfolio
On: 23rd February, 2016 // By: admin
A Strategic, Diversified Portfolio Minimizes Risks, Maximizes Earnings
Creating a diversified portfolio is a cornerstone of sound wealth management, because it is the single most effective step you can take to protect your assets. When you diversify, you spread your wealth between a variety of investment types and industries. Different investments categories will react in different ways to any given event, so taking this step keeps the majority of your assets safe, even as one segment may reel from a negative event in the market.
A discussion of the types of risks to your assets may help fuel your interest in a more diversified portfolio. Here are two types of risks that you will encounter with your investments:
An undiversifiable risk, also called a systematic or market risk, is not associated with a particular company or industry. It can come in the form of rising inflation, political instability, war or a change in interest rates. These risks are the type that you have little to no control over.
A diversifiable risk is also called an unsystematic risk, and it is a risk specific to a particular industry, company, market, country or economy. Diversification mediates these types of risks by investing in a variety of assets so that all of your investments are not affected in the same way by an event.
The Importance of Diversification
Here’s an easy example that drives home the importance of a diversified portfolio. Imagine that it’s 2007, you are five years from retirement and you have invested the bulk of your retirement assets into General Motors, because you love GM cars. Not only do you believe that they have a quality product, but you once had a customer service issue that was handled with particular care. You follow stories of their commitment to quality and their high customer satisfaction rating.
However, since you have already lived through 2008, you know that any investor about to retire within five years was suddenly looking at their portfolio, trying to figure out if they would need to extend their working years. If you had all of your stock invested in GM, you would have been horrified to watch it dip below a dollar per share in 2009.
Thankfully, the lessons of the recession are there to guide you in your efforts to build a diversified portfolio. Particularly if you are nearing retirement, your focus on diversifying should be well-informed by the priority placed on protecting your wealth. Your mix of investments should reflect a lower tolerance for risk as you close in on retirement.
It’s also important to diversify, not only between industries, but also by the type of investment. After all, the investment story above would not have been helped much by a portfolio that was spread between not only cars, but also other types of manufacturing and products. Real estate and the stock market suffered heavily, so investors that had invested in bonds and cash were better protected than those that invested in the stock market and real estate.
Aura Wealth Advisors provides guidance to clients wanting to build a diversified portfolio that protects their wealth, but also works to increase it over the long term. If you are interested in talking more about diversification, please call the Aura Wealth Advisors office to make an appointment.