We know we should go to the doctor regularly for a physical. But what you may not realize is you should do the same kind of annual “checkup” on your investments. You may already pay attention to your portfolio when the market is riding high. After all, who doesn’t get excited to see the dollar amount of their assets growing? You may even look at your portfolio’s performance when things are not going well, anxious about how much of a hit you may take financially. Reviewing your investments regularly, however, is best—not only to give you a clearer picture of their true value, but also to let you know when it is time to diversify.
Why should you diversify?
We talked about performing a checkup on your portfolio above. Now let’s explain the role diversification plays in that. You may be tempted to think of diversification as a means to boosting the overall value of your assets. That’s not really what diversifying is about. Even in a well-diversified account, you can experience losses—that is simply the nature of investing.
However, diversification can help to contain losses when the market becomes volatile. That is why the metaphor that so many financial advisors use to explain diversification is “Don’t put all your eggs in one basket.”
What does it mean to diversify?
When discussing diversification with your financial advisor, there are three areas you need to consider—the level of risk you are comfortable with and that coincides with your ultimate retirement/investment goals, the amount of time before you retire or need to draw on those invested funds, and how much market volatility you think you can handle.
The answers to these questions will determine how you allocate your investment funds between stocks, bonds, cash and other investments. Another aspect of diversification is how you divide up your money within these different types of investments. For instance, the common advice is not to concentrate too much of your investments into a single stock. An additional tip is to consider market capitalization, spreading your funds between small, mid and large caps, as well as different market sectors and geographic regions.
How can diversification protect you?
There will always be risks when it comes to investing. The goal of diversification is to help mitigate the ups and downs that the stock market can experience over time. That is why the process of diversifying your investments is not something you do once and then forget about. Reviewing your asset mix on a yearly basis, or when you experience a major life change, is a good idea. When you see that your investments have started to drift away from your comfort zone for risk, time and market volatility that is when you want to talk about rebalancing your portfolio.
No financial advisor or investor knows what investment asset classes will perform better than others or when they won’t. Investing is a long game, but staying aware of your portfolio’s balance and adjusting it as needed, is always smart.