Regularly investing from an early age is key to growing your wealth. Diversification is imperative for smart investing. A diversified portfolio reduces risks by ensuring that your fortunes aren’t bound to only a few investments. Learning how to build a diversified stock portfolio is especially important in the face of volatile market conditions. A great way to achieve such a portfolio is to find asset classes with negative or low correlations. So, if one class’s value drops, the other class counteracts the loss. Keep reading to learn about the best ways to diversify your stock portfolio.
Ways to Build a Diversified Stock Portfolio
A well-diversified portfolio of stocks means a mix of cash, bonds, government securities, and the like. When you have more capital and feel confident in your choices, you can diversify into international markets and real estate.
Here are the key ways to make your stock portfolio diversified.
1. Don’t just invest in stocks.
Many investors habitually put their money in a single stock or a sector. But you must try spreading your wealth. This means investing in commodities, ETFs, exchange-traded funds, and real estate investment trusts.
The more you spread your risk, the more substantial the rewards. However, do not venture too far here. Diversifying does not mean creating an unmanageable portfolio. Although you should invest in things apart from stocks, it doesn’t mean investing in a thousand different vehicles.
2. Try low-cost options like index funds.
Add index or fixed-income funds to your portfolio. It’s a kind of mutual fund or ETF with a portfolio that matches the elements of a financial market index. This can be S&P 500.
Index funds are regarded as the best core portfolio holdings for individual retirement and 401(k) accounts.
Also, use index funds to boost your exposure to particular sectors. Although they can be a bit more expensive than those that monitor popular indexes, it makes you actively manage your portfolio.
3. Invest in a Systematic Withdrawal Plan (SWP)
Every investor is aware of mutual funds, one of the safest investing options. However, note that mutual funds further have more options for more effective investment. If your money is part of a savings plan and you cannot touch it, investing SWPs will be wise.
In them, you can take out a specific sum quarterly or monthly. Also, it is possible to customize withdrawal. You can opt for withdrawing against profits or simply taking out a fixed amount.
4. Invest in Target-Date Funds
Target-date funds rebalance your portfolio with the right amount of bonds, stocks, and money market accounts. These mutual funds bought from other mutual funds (fund of funds) update your asset allocation with the passage of time.
When you start with such a fund, for instance, in your early work life, the target-date fund allocates a greater part of your portfolio in stocks. A lesser part of the portfolio is allocated towards safe or fixed-income investments that give less returns. But as you approach your retirement years, the fund automatically moves toward safer investments.
5. Use alternative investments
Alternative investments are those that don’t convert into cash easily. The United States Security and Exchange Commission or SEC does not regulate these investments. These are all investments apart from stocks, bonds, and cash. Some examples are:
- Hedge funds: These funds gather the capital of different investors and invest it across securities. The goal is to manage risk to surpass the current market rate of return.
- Private equity: It means the investment of capital in private firms. Private equity includes buyouts, growth equity, and venture capital.
- Real estate: Its an investment of capital in retail, commercial or residential property.
- Debt investing: It means capital that you invest in the debt of a private company.
- Commodities: Here, you invest capital in natural resources like timber and oil.
- Collectibles: It implies the purchase of rare items like wines and cars and selling them when their value enhances.
7. Diversify within companies
it is also essential to diversify within companies according to different themes. Combine those companies in your portfolio with greater operating margins with those having more asset turnover ratios.
Likewise, high-growth stocks should be coupled with high dividend yield stocks to ensure a positive net outcome.
How to Calculate Portfolio Diversification?
You can measure the diversification of your portfolio by recording the percentages for every kind of asset for every type of investment. Another method is to download historical prices of a year for all the assets in your portfolio. Import that data into a spreadsheet and set it to calculate standard deviation and correlation.
This can be a time-consuming and complicated method. If you find this process challenging, connect with a financial advisor. They have access to advanced programs that will give you a more accurate result.
The Benefits of a Well-diversified Portfolio
Diversification increases the likelihood of better returns for the level of risk you target. This kind of portfolio consists of different investments, such as bonds, stocks, and cash, among others. These are those investments whose returns do not give the same results. Diversification benefits you in the sense of balancing the declining value of one asset.
When you spread your assets across different areas of the stock market, you effectively reduce your portfolio risk. At the same time, you maintain your exposure to market growth. You may not realize the value of such a portfolio immediately. But over time, it will help you to generate wealth.
To build a diversified portfolio, a great strategy is to hold a mix of energy, tech, healthcare, and stocks from other industries. Your aim should be to hold stocks of various high-quality companies. It’s also worth considering adding small-cap and large-cap stocks, growth stocks, value stocks, and dividend stocks. Additionally, you can hold some non-correlated investments. These refer to those investments whose prices do not change, like the stock market indexes. Some examples include gold, real estate, cryptocurrencies, and bank CDs.
Diversification is all about minimizing exposure to a single industry, stock, or investment option. Selecting the right mix of investments and periodically monitoring your choices will help you achieve your long-term financial goals.