Diversification: The Key to Smart Investing
The process of investing for the future is filled with challenges and triumphs. We try to invest wisely, balancing our tolerance for risk against the possibility of positive returns on our investments. Most people are careful with the funds they invest, but it is all too easy to succumb to excitement or that “sure thing” our friends and financial advisors suggest. In the world of investment, there is only one sure-fire method to ensure financial security, and that is the concept of diversification. In this guide, we’ll explore what that means and how diversification can help you enjoy a bright and stable financial future.
Diversification: The Basics
In simple terms, diversification means investing in multiple types of assets; in effect, spreading your investment funds over broad categories instead of focusing on one or two specific investment vehicles. For those preparing for retirement, diversification can mean opening and funding multiple retirement accounts, such as IRAs, 401(k) plans, and even accounts like annuities. Investors on the stock markets will diversify, spreading their assets across multiple market sectors. The principle behind diversification is simple, too — it offers a measure of protection against market swings.
Imagine that you have money to invest and choose to target real estate properties for your investments. You put all of your money into real estate and all is well until the market crashes. What seemed like a sure thing now means significant challenges and a potential to lose all of your hard-earned assets. If all your money is tied up into one investment category, you are at the mercy of market forces.
Here is another example: your friend tells you that the technology sector is heating up and the time is right to make huge investments in this sector. All of your investment funds go toward purchasing stocks in technology companies, and for a time, you’re seeing substantial growth on your investments. Then, the market takes a downturn, and you stand helplessly by as your assets dwindle. Meanwhile, other market sectors are booming — automotive, pharmaceutical, blue chips — and investors in those sectors are making huge profits. Failing to diversify means you miss out on opportunities for growth and may lose some or all of your assets when markets take a tumble.
Strategies for Diversifying Your Investments
Smart investing is a complex process of identifying opportunities, researching trends, and measuring risk tolerance. It can be a careful balancing act for even the most experienced investment professional. Most financial experts tell their clients to diversify, and some confusion exists as to what that actually means. Diversifying your investments hedges your bets, balancing risks and rewards in a manner that can help protect your assets.
For retirement planning purposes, investors should consider opening multiple retirement accounts. Many employers offer some form of pension or 401(k) plan, and it is a good idea to enroll in these plans if available. In addition to an employer-sponsored plan, opening one or more IRA accounts is a smart move. IRAs, either Traditional or Roth, offer certain tax advantages, and the assets grow in value until you reach retirement age. Money can also be used to invest in real estate, stocks and bonds, mutual funds, or even collectibles — each of these investments has the potential to weather market forces. Having multiple retirement accounts protects your funds against market downturns, preserving more of the funds you’ll need for future expenses.
Traditional stock and bond investors should attempt to avoid the hot trends, instead targeting more stable markets. Investing in multiple market categories protects at least some of the investment against losses; it is unlikely that all market sectors will be affected by a severe downturn. There are numerous market sectors to choose from, including:
- Heavy equipment manufacturing
With the wide range of possibilities, it makes sense to spread investment funds among these many categories. Diversification isn’t foolproof, but it is a time-honored strategy used to take charge of your financial future, helping to protect you and your assets from the ups and downs inherent in any investment.