About Diversifying

It's time-tested and true: Don't put all your eggs in one basket. If you haven't diversified your portfolio already, start the process right away and spread your money around to minimize risks. Where you invest depends on your income, age and expectations on returns. How you invest will determine what your portfolio's worth down the line.

Determinants of Investments

The three key determinants of personal investment are income, age, investment time horizon and the rate of return. Your diversification strategy will depend on your ability to bear risk (business risk, valuation risk and economic risk). Fixed income investments such as U.S. treasury bonds provide guaranteed returns, reducing the volatility of your portfolio. The younger you are, the more risk you can bear since you can put your money to work over a longer period time. So any losses will simply remain in the books until the next upswing. For example, when choosing an age-based 529 college investment plan, pick an aggressive plan if your child is more than 15 years away from attending college, a moderately aggressive plan in case of less than 10 years and a conservative plan for less than four years.
Whether you invest in open or close-ended funds will depend on when you need your money back. If you know you need to fund contingency expenses (as in a medical condition that requires frequent treatment), choose investments with exit options that have no or minimum penalty.

Diversifying Across Asset Classes

According to the Investors Capital Management, Inc., "Modern portfolio theory shows that diversity amongst different non-correlated assets will reduce risk and enhance returns. A mixture of stocks, bonds, commodities and cash offers a well-balanced portfolio."
According to Edward Jones, you can choose from among the following investment vehicles: Cash and cash equivalent, income funds, growth and income funds, growth funds and aggressive funds.
Like a salad with a smattering of multiple ingredients, your portfolio should contain at least three or more of these investment vehicles. Equity (401 [k] plans, mutual funds, or directly via E*Trade, Scott Trade or TD Ameritrade), bonds (government and corporate), real estate (residential, commercial or vacation property and real estate funds), currency (primarily dollar or euro) and commodities (physical assets such as gold or exchange traded funds for metals---ETFs).

Diversifying Within Asset Classes

You need to diversify within your asset classes. With equities, include blue chip (less risk) and mid- and small-cap companies (more risk) and stocks across different industry sectors---if one industry is hit by a slowdown, the value of your capital does not crash. Pick up stocks in both domestic and emerging markets so that a decline in one will be balanced by the other. While choosing fixed income securities such as bonds and certificates of deposit (CDs), include government and corporate bonds and bonds that mature at different dates.

Riskier Diversifications

Riskier investment options such as private equity, venture funds or hedge funds require significant capital and tolerance to risk. Speak with your financial advisor to determine if these options are good for you.

Criticism Against Diversifying

Investment guru Warren Buffett said: "Wide diversification is only required when investors do not understand what they are doing." He also said: "Why not invest your assets in the companies you really like? As Mae West said, 'Too much of a good thing can be wonderful.'"
According to "Warren Buffett Secrets," in 1992, Buffett said his investment strategy was focused on investing in a limited number of companies.
"Many pundits would therefore say the [this] strategy must be riskier than that employed by more conventional investors. We disagree. We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort-level he must feel with its economic characteristics before buying into it."

References

• Investors Capital Management, Inc.
• The Investment Pyramid, Edward Jones
• Warren Buffett Secrets