Many financial advisors strongly recommend spreading the money you have around or “diversify” investments in order to save money. Diversification will protect you from losing assets when the market fluctuates. Stock prices have declined dramatically in recent years especially on the international market such as Australian stock exchange share prices and proves that putting all your money in one place can be risky. However in order to diversify you need to understand what investments to buy and exactly what amount of money you should put in each one. You also need to understand exactly how to diversify your money within a certain category.
Being diversified doesn’t mean having several different investments. When you are diversified you have several different types of investments. This includes having bonds, stocks, international securities, real estate funds and cash.
When you have investments in each of the following categories they can do several different things:
- Stocks will help you grow your portfolio
- Bonds will create income
- Real estate will provide two things, a hedge to protect against inflation and protection in the event stocks fall. For example a low “correlation” can rise in the event stocks fall.
- International investments will also provide two things growth and assist in maintaining buying power.
- Cash will give you and your portfolio both stability and security.
Exactly how do you determine what amount to put into every investment category? The first thing you should do is put aside enough income investments and cash so that emergencies are covered as well as short term goals.
The next thing you need to do is strictly follow one rule. Whatever your age is subtract it from 100 to get the percent you should put into stocks and put the rest into bonds. For example, if you are 30 years old put 90% of the total of your assets into stocks and 30% into bonds.
To diversify your money between several investment categories all you need to do is adjust the percentages from using this rule of thumb:
- Invest in international securities by investing between 10% and 25% of the total stock in your portfolio. The younger you are and the more affluent you are the higher the percentage should be.
- You can decrease 5% of your stock portfolio and decrease 5% from the bond portion of your portfolio then invest that 10% into REITs or real estate investment trusts. This is a hybrid investment which produces a stock like return however the return is in dividends. Securities can be volatile and swing wide in value. However they move at a significantly different pace than all other investments but will help to stabilize returns.
The 20 year old used in the example above would have a fund for emergencies as well as the remaining split between 75% stocks including 25% international stocks, 10% REITs and 15% bonds.
After you have diversified all of your assets into several categories you then have to diversify it again. It is never enough just to buy one stock for example, you should have several types of stocks in the stock portion of your portfolio. This will protect you from suffering severe losses when on industry decreases in value.