When talking about investing, most money managers advise their clients to spread their money around or diversify their investments. Doing this will protect you from losing everything if the market heads south. The way stocks have declined in recent years is proof that putting all of your eggs in one basket can be quite risky.
However, if you want to properly diversify, you need to know what to invest in, how much to invest, and how to diversify even within a single investment category.
Variety Over Quantity
Having many investments doesn’t mean that you have diversified. You need to have lots of different types of investments. That means that along with investing in zcash mining and other cryptocurrencies, you should also have international securities, real estate funds, bonds, stocks, and cash.
Investments that are made in these asset categories each do different things.
The Allocation of Money
How do you determine how much money to sink into each category of investments?
First, you should set aside enough money in income investments and cash to take care of any sort of near-term goals and emergencies.
Next, a rule a lot of money managers stick to says that you should subtract your current age from 100 and put that amount into stocks and the rest of it into bonds. For example, if you are 40 years old, you would put 40% of your money into stocks and the rest into bonds.
After that, if you want to diversify your money with the other groups of investments, 10% - 25% of the stock part of your portfolio should be in international securities. Take 5% of both the stock and bond portfolios and use this money for real estate investments.
Diversifying Within Categories
Once you have diversified into different categories, you need to further diversify within those categories. It isn’t enough to simply purchase one stock. You need to have many different types of stocks. Do your research to determine which ones will be the best investments. This will protect you from being devastated if a single stock takes a dive.
If you don’t happen to be uber-rich, diversification while you are purchasing individual shares can end up costing you a lot. This is due to the trading fees you have to pay when you buy each one. The most cost-efficient way to do this if you have a modest amount of money, is to invest in mutual funds.
Mutual funds are a sort of investment pool that combines the money many people have invested to buy things like international securities, real estate, bonds, and stocks.
Risk vs. Return
Diversification can protect you from losses that are devastating, but it can also cost you when it comes to returns annually. This is because reward and risk go hand in hand when it comes to the financial market. This means that anything that will reduce your risk will also reduce your return.
The best answer is a combination of these that works for you. If a bit of additional risk won’t keep you awake at night, you might be able to get higher returns. But if you’re more worried about the risk, you might want to stick with safer investments.