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Most people think that they have diversified assets if their stock portfolio contains 30 different securities. However, that’s a narrow way of looking at your investments and net worth as a whole. While you might have diversified risk in equities, you may not have it elsewhere.
Consider, for instance, your property or a business you own. When you include those, can you really say you’re diversified? What about commodities and precious metals holdings? Do you have some of them in your asset collection as well?
If you don’t, you could be one of the many people who believe they are diversified when they are not. You might be living your financial life under the impression you’re protecting yourself against shocks when you aren’t.
This post explores why you probably need to diversify and how to diversify your assets. Read on to learn more.
How To Diversify Effectively
Diversifying your assets means spreading your money across different types of investments, such as stocks, bonds, cash and alternative investments. Economic theory says that this approach helps you reduce your overall risk and increase your potential returns.
There are plenty of things you can do to diversify your investments. The first thing to do is to determine your risk tolerance and investment goals. This will help you decide how much of your portfolio you want to allocate to each asset class.
Most people don’t go through this first step because they believe all they require is a brokerage account. However, that’s not true.
It also depends on your goals and objectives. For example, if you are young and have a long-term horizon, you may want to invest more in stocks than bonds. If you are near retirement and need income, you may want to invest more in bonds than stocks.
The most important step is to choose a variety of investments within each asset class. You want some investments in equities, bonds, precious metals, real estate, and commodities.
For instance, if most of your net worth is tied up in your personal business, then it might be a good idea to go to a business broker. People in situations like these are often far too invested in their own companies, and not sufficiently invested in others.
If you invest in equities, consider investing in index funds or exchange-traded funds (ETFs). These are funds that track the performance of a specific market index, such as the S&P 500 or the FTSE 100. They’re cheap, easy to manage, and often contain hundreds of securities, all managed by professionals and advanced algorithms.
Don’t be afraid to invest a small proportion of your wealth in alternative investments. These include private equity, crypto, and art. These investments may have out-sized returns collectively, particularly when viewed as a group. Furthermore, they tend to be uncorrelated with each other, which is nice when markets fall.
Always regularly rebalance your portfolio. This means adjusting your portfolio periodically to maintain your desired asset allocation and risk level. Don’t let it become uneven as this can harm your long-term returns.
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