What Are The Benefits Of Diversifying My Investments?
Diversification is one of the cornerstones of traditional investment advice. The most common saying we hear is “never put all your eggs in one basket” and the moral holds true. Markets will go up and down based on economic changes, business cycles, pandemics, presidential elections and media commentary. Managing these peaks and valleys is the primary goal of an investment plan. Although it does not guarantee any positive or negative returns, the best possible defense in any investment strategy is diversification and a well thought out financial plan.
The most basic form of a diversified investment strategy is a mix of stocks and bonds. Generally, those two asset classes perform differently depending on the market conditions of the day. Stocks often perform well when the economy is growing, unemployment is low, and consumers are confident. Low interest rates often help to generate stock market gains. When the cost of borrowing money is cheaper, it is easier to find capital to invest in the markets and businesses.
On the other hand, bonds typically perform well in times of trouble. Bondholders have better protection against downturns in the market as they get paid out first in bankruptcy proceedings or corporate restructuring. The last investors to get paid are the stockholders. However, stockholders benefit from a greater upside (dividend growth, increased stock value, etc). Bonds are often considered “safer” than stocks for many reasons, but both assets work together in a diversified portfolio.
While it’s tempting to just own stocks in good times and bonds in bad times, it’s not easy to predict which way the market will move. If it were, we'd all be rich! By holding a mix of stock and bonds, you allow yourself to take advantage of the upside when markets are rising, yet protect yourself on the downside when markets are falling. Either way, volatility is normal and to be expected. A Certified Financial Planner (R) professional can help you choose just the right mix of stocks and bonds (and exactly what to buy in these asset classes) to meet your financial goals.
The spectrum of investment choices out there is very broad, and it’s nearly impossible to have a “perfectly-diversified” portfolio. Luxury goods such as fine art and collectibles could technically be part of a diverse investment strategy along with foreign currency, cash, real estate, and literally anything you can buy and hold. In practice, diversification is a guiding principle more than a concrete strategy.
Diversified portfolios should include more than just a mix of asset classes. It’s important to diversify within those asset classes by holding investments across countries, industries, size, management style, and investment alternatives. For example, if you hold all of your investments in Canadian dollars or US currency, you are open to currency risk. If you only invest in large-cap stocks (i.e. the biggest companies), you will miss out on returns when small cap or international stocks are in favor. History has shown there is no telling when one sector will out perform another, therefore it is best to hold a diversified portfolio. Diversification is one of the most proven investment strategies to generate returns and limit risk over the long run.
Work with a Certified Financial Planner (r) professional today to understand your unique situation and create an investment portfolio that is allocated and diversified properly and meets your goals, time horizon and risk tolerance. Just remember, it is not a race, and one quarter or one year doesn't make a winning or losing portfolio. Those who stay invested, diversify their portfolio, and follow a financial plan will certainly reap the benefits!