You may have heard this before: a diversified portfolio is a key part of a long-term investing plan that works. But what does it mean for a portfolio to be diversified? Probably more than you think. A big part of it is having a mix of stocks and bonds. But there is still a lot of difference within the stock market. It all needs to be different.
Domestic vs foreign
We all like to encourage the home team, but it can be smart to invest in players from other countries. Your international stocks could come from a developed nation like Canada, the U.K., and France or developing markets like India, Brazil, Russia and China. The first group is usually safer because their economies are relatively stable, while the second group has more room to grow.
Market capitalization
“Market cap” is the value of a company, which is found by multiplying the share price by the number of shares that are still in circulation. In general, a small-cap company has a market value of less than $2 billion. A large-cap corporation is one with a market value of more than $10 billion.
Small-cap companies usually have more risks because they are newer and have less access to capital (aka cash). Also, investors might find it harder to do their research because analysts are less likely to write about them.
Value vs growth
A growth company makes a lot of money and has enough money to keep growing. Prices can go up a lot, which can appeal to investors, especially when the market is going up. On the other hand, a value company’s stock is cheap compared to its sales and earnings. Its stock price may have gone down because of something in the news or similar stocks. If the stock price goes back up, investors who want to buy it could get a big return. When putting together a balanced portfolio, you want to have both types.
Industry
Every business has a name that describes what it does. Facebook and IBM, for example, are both in the tech sector. Financials, buyer staples, health care, and real estate are some of the other sectors. Companies in the same sector tend to do about the same, so it’s smart to spread your investments across several categories.
And make sure you have both “defensive” and “cyclical” stocks. The first one is pretty stable in any market, while the second could do very well in a certain economic situation. Cheng says it might be a good idea to invest in building materials, construction, and industrial companies when they are growing. On the other hand, market cycles don’t affect consumer staples and technology.
What do you think about bonds?
It would help if you bought a mix of bonds from corporations, states, and local governments (called “munis”) and the federal government (“Treasuries”). Each of these varieties of bonds has different risk and expected return level. Corporate bonds have the most risk and the most potential return. Since the U.S. government backs Treasuries, they are seen as having a low risk. Munis are about the same.
You can also keep your bond portfolio in balance by buying bonds with different due dates. Short-term bonds have a maturity date of five years or less, intermediate bonds have a maturity date of five to 12 years, and long-term bonds have more than 12 years.
Anything else
A person who wants to invest might look at things other than stocks and bonds. These are called “alternative investments.” This includes real estate, commodities, cryptocurrencies, even art and antiques, and anything else that doesn’t fit neatly into the stock or bond box. They are usually seen as more complicated and risky, so new or casual investors avoid them. However, institutional investors and “high net worth individuals” pay a lot of attention.
But mutual funds and exchange-traded funds (ETFs) make it easier for most people to invest in alternatives. For example, both Vanguard and State Street have ETFs that focus on real estate and invest in various real-estate investment trusts (REITs). State Street also sells a few commodities, such as two ETFs for gold and two for natural resources. If you want to boost your portfolio, these kinds of funds could be a good choice. But most experts say that this type of investment should only make up a small part of your overall portfolio, maybe 5 percent or less.
Also, there’s money. On the opposite side of the risk scale, cash and cash equivalents give your portfolio a safe place to hide. Just remember that if there isn’t much chance of losing money, there isn’t much chance of making a lot of money. It would encourage if you also thought about inflation, making your cash investments less valuable. So you shouldn’t be too careful and put too much of your portfolio into this category.
What does a portfolio that is well-placed look like?
It depends on several things. The most major thing for an investor to think about is how much threat they are willing to bear and how much risk they can take.
If an investor is 26 and saving for retirement or a long-term goal and is willing and able to take on many risks, they may do best with an aggressive portfolio. Ponnapalli says that could be about 90% of stocks, 30–35% of which could be from overseas, with half coming from emerging markets. He says that people getting close to retirement should cut back but still put most of their money in stocks instead of bonds may be a 70/30 mix. He also suggests reducing the amount of money invested in foreign and emerging markets.
This seems to be a lot of effort. Someone else?
In fact, yes. It’s a really good idea. To build and keep a well-diversified portfolio, you need to trade individual stocks and bonds. This takes a lot of research and may cost more time and money than most individual investors would like to spend on investing. And if you get it mistaken, you could lose a lot of money.
On the other hand, mutual funds and ETFs use the knowledge and experience of experts to do the real work of building a portfolio. It also lets you invest in dozens or even hundreds of companies. Plus, especially ETFs and index funds, funds give you a wide range of options at a low cost. That makes it as comfortable as investing and reaching all your financial goals.
