The Importance of Diversifying Funds When Investing

Oct 29, 2013 12:12:32 PM / by Jason Shaw

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How you allocate the assets in your investment portfolio is the primary determiner of its return and volatility over time.  All investments involve risk.  The goal of asset allocation and diversification is to balance risk and potential gain across the portfolio.  While aggressive investment in stocks exposes you to greater risk of loss, investing too conservatively carries the risk of underperformance and failure to outpace inflation.  Read on to learn about how you can appropriately allocate and diversify the assets in your portfolio to fit your savings goals.

Asset Allocation

Historically, stocks, bonds, and cash have not all risen or fallen in performance at the same time.  Generally, conditions that will cause one class to do well will cause another class to perform marginally or poorly.  Consequently, spreading your funds across classes will help you weather downturns in one class of investments by taking advantage of growth periods in other classes.

Remember that your risk tolerance and time horizon are the key considerations when deciding how to allocate your assets.  CNN Money offers a calculator that provides asset allocation recommendations based on time horizon and risk tolerance.  Although this can give you a good first impression of the type of asset allocation you should be considering, it should be used only as a general guide.  Always talk to a knowledgeable, professional financial advisor for individually tailored guidance about your own optimal allocation.

 

Dangers of Overly Conservative Investment

If your time horizon is long, you must pay careful attention to inflation risk.  Investing too conservatively can drain your portfolio of purchasing power over an extended period of time.  With a long time horizon, inflation risks may outweigh market risks, so heavier investment to stocks is often advisable.

 

Finding the Right Mix for Your Goals

To give you an idea of how different blends of stock, bond, and cash investments tend to perform across different time horizons, The Vanguard Group provides an interactive graph that illustrates historic performance of any combination you enter.

Although historical data is a helpful tool in determining appropriate asset allocation, it is important to recognize that market conditions change over time, so it is important to periodically review your portfolio with a professional to reassess what allocation is currently appropriate to your goals.

 

Diversification Within Asset Classes

It is not enough to craft an appropriate mix of stock, bond, and cash investments.  Also diversifying your investments within these classes will help to minimize your exposure to the risk of catastrophic loss.  Although a particular asset class in your portfolio may perform poorly as a whole for a period of time, some investments within that class will perform better than others, so spreading your risk across a variety of investments can prevent you from losing more than necessary when the market turns.  For example, Investopedia suggests that a stock portfolio containing 15-20 different investments across various industries can achieve optimal diversification within that class.

 

Boelman Shaw Capital Partners in Des Moines offers our clients knowledgeable investment advice, as well as professional tax preparation and planning.  Because we are skilled and experienced in both fields, we can provide more complete, individualized advice to our customers, shaping portfolios to suit individual goals while also considering the tax consequences of investments.  Boelman Shaw is an independent financial consulting company.  We don’t sell particular investments.  We are in the business of advising our customers of their best options and helping them to realize their goals through educated financial management.

 

Material discussed herewith is meant for general illustration and/or informational purposes only, please note that individual situations can vary. Therefore, the information should be relied upon when coordinated with individual professional advice.

Topics: Financial Planning

Written by Jason Shaw