You may have heard that investment diversification is important during a volatile market, or during an unstable economy. And that not being properly diversified can expose you to unnecessary risk. So then just what does diversification mean?
Diversification is simply the use of a variety of investments or asset classes to reduce your overall risk exposure. Risk of loss, interest rate risk, inflation risk, market cycle risk, ect. When you diversify, you are spreading your money across several different assets. Various assets include: Stocks (large, mid, small – in different industries & countries), Bonds (government, municipal, corporate, high-yield), Real Estate (residential, commercial, REITs, tax liens, raw land), Commodities (gold, silver, corn, wheat, ect), and Cash (or cash equivalents). While diversifying can’t completely eliminate overall risk exposure (nothing does), it will however help reduce your overall exposure to the different types of risk.
Portfolio diversification can be illustrated in this way: Picture two elevators in a high-rise office building. One elevator had 7 cords that raise and lower it, and the other only has 1 cord. Which one would you take? The obvious choice is the elevator that has more cords, because if 1 cord snaps you won’t come crashing down. There’s strength in numbers.
I’m sure you’ve heard the saying “Don’t put all your eggs in one basket”. Reasoning is if that one basket drops, there go all your eggs. By putting a few eggs in several different baskets, you don’t lose everything if one basket falls.
Still need more convincing? The Bible speaks of diversification as well (regardless of your faith or beliefs, good advice is still good advice). The book of Ecclesiastes in chapter 11 verse 2 (in the English Standard Version) reads: “Give a portion to 7, or even to 8, for you know not what disaster may happen on earth.” Apparently, the advice that King Solomon gave some 2,900 years ago still applies to today’s financial markets.
As a side note, that same Bible verse can also be applied to Business – diversify your product offerings to your target markets, and also to Giving/Philanthropy – diversify your giving to various charities and causes.
Mutual funds can help you to easily diversify among various assets. An important point about diversification is to diversify your money among different asset classes, not the same ones. Owning 3 large cap growth funds and 3 intermediate-term government bond funds from several different mutual fund companies isn’t a diversified portfolio. It’s just a mishmash of funds that isn’t very efficient.
We at Malleo Financial Services can work with you
to develop a properly diversified investment portfolio.
For a free consultation, please contact us for an appointment.
*This blog is strictly the opinion of Michael A. Malleo and not those of
ASH Brokerage Corp., Quest Capital Strategies, Inc., nor any of our affiliates.
Malleo Financial Services LLC cannot and will not give any specific tax or legal advice.
Please consult your tax professional or legal professional for such advice.