When the global economy is growing and stock market prices rise, it can be impossible to sell an asset lower than its original price. However, the economy is ever-changing, making it difficult for investors and traders to correctly predict market conditions. This is why investors need to have a diversified portfolio to prepare for any market condition.
According to a study published in The Journal of Portfolio Management, “diversifying a portfolio is a great way to safeguard your investments from any potential risks and losses. It helps investors minimize any bumps they will face in their investment journey.” The more diverse your portfolio is, the more stable the returns will be, diffusing most investors’ overall risk. Remember that diversification doesn’t guarantee better returns or fewer losses; rather, it merely is a technique that can help you reach your long-term financial goals.
For an investor to truly achieve portfolio diversification, understanding every type of investment vehicle and when it should be used is essential. For example, funds invested in short-term goals should be invested differently than those for long-term ones. Generally, the longer the investment period, the more risk investors can afford to take with it.
When starting a portfolio, it is crucial to define your goal, timeframe, and risk tolerance. Investors must build their portfolio in agreement with correlation. Correlation is the degree to which the investment vehicles move in tandem. Keep in mind that if your entire portfolio moves together, it is not diversified. Ensure that your money is spread in assets that don’t go up and down simultaneously.
While investing in traditional assets such as stocks and bonds is a good starting point for diversification, other strategies should be considered. Here how you can start:
Allocate your asset
According to the Risk and Asset Allocation book by Attilio Meucci, “asset allocation is an investment strategy that adjusts the percentage of each asset in an investment portfolio in an attempt to balance risk versus reward. It is made in accordance with the investor’s risk tolerance, goals, and investment timeframe.”
Several assets can be used for diversification, and it is up to the investors to spread these funds. Keep in mind that there is no simple formula that can be used to find the right asset allocation for every investor.
Consider investing overseas
When it comes to investments, most investors are biased toward domestic securities. But to truly diversify a portfolio, international exposure is necessary. Investors can find several growth opportunities overseas with global stocks. The reason is that every country’s economic growth is different. International assets such as stocks play a significant role in portfolio investing since more economies mature globally.
Take advantage of alternatives
Alternatives or alternative investments are a type of assets that are not correlated with traditional ones. This means that their value does not usually rely on a country’s economy. Alternatives include commodities, real estate, and digital assets. This type of investment can be a perfect addition to any portfolio, especially when partnered with an investment strategy that does not rely on its value, such as arbitrage.
“Arbitrage is an investment strategy that does not rely on any economy. Instead, it takes advantage of price differentials in the market. By using arbitrage in your assets, you are broadening your diversification by trying a strategy that works in any market condition. This can help any investor lessen their losses when economies are in a downturn,” says Dr Thomas Jefferson, CEO of Everest Holdings, a digital asset management company.
Invest in index or bonds funds
If you consider investing for long-term goals, investing in securities that track different indexes can be the right choice. According to a paper published in the Journal of the Operational Research Society, “an index fund is an investment vehicle which mimics a stock-market index and thus exhibits market risk only.” By adding some fixed-income solutions, investors can further hedge their portfolios from market volatility and uncertainty.
If investors know how to manage their assets, investing can provide a viable profit. To help mitigate risks and losses, investors must diversify their portfolios. There are various ways investors can safeguard their investments. Choosing which one suits them best, plus a proper diversification strategy, will help grow their portfolio and achieve its maximum potential.