Investment gurus and best-selling personal finance writers intone the value of diversification. And with good reason. A diversified portfolio -- one with a weighted proportion of investments -- offers the investor a way to spread risk, receive long-term benefits and short-term gains. This can, and will, shift with your age, experience and goals. Play around with different percentages and scenarios to find a combination that works for your personal targets: saving for college, retirement and large purchases, such as your first home.
Diversification: Three Keys
Age, time and risk tolerance. These three pillars support your portfolio management and act as a guide to sift which assets will add value. Investors in the 50-plus age range may weight their portfolio with a higher percentage of fixed income assets and dividends; younger investors might allot themselves more risk capital for speculation and growth investments. Keep in mind that precious metals, real property and other ill-liquid assets, such as collectibles, assume a role in your total holdings. Bankrate.com has an asset allocation calculator to graphically show you how time and capital affect the distribution, growth and returns of your investment.
Depending on your investment goals, stocks should comprise roughly 65 to 75 percent of your portfolio, according to Smart Money. This asset class has many products, from mutual funds, dividend paying stocks, exchange traded funds (ETFs) and index funds. Because of the volatility of the markets, stocks can experience sharp swings in valuation. But even given periods of radical fluctuations, stocks have historically increased in value over time. The “buy and hold” strategy, where patience pays, works for holding equities long-term. You can create subsections of your stock strategy, with a percentage of small-cap, mid-sized companies and large-caps represented.
When a company, state or municipality wants to to raise capital, it will issue a bond and use the generated proceeds for capital expenditures. The government issues bonds as well, with various maturities, face values and yield rates. Trillions of dollars flow through the bond market and the low volatility and guaranteed redemption make them a slam dunk for your portfolio. Interest rates concern bond holders; when interest rates rise, bonds already issued decline in value, and vice versa. These fixed-income securities should make up approximately 15 percent of your portfolio.
Liquid assets include cash, treasury bills, your savings and money market funds. Cash accounts have the lowest rate of return but offer safety, and for FDIC accounts, insurance. Cash equivalent investments can depreciate in value as inflation rises; as prices rise your dollar has less purchasing power. While there’s no hard and fast rule about the percentage of cash you should allocate, start with around 10 to 15 percent. Having enough cash on hand gives you the flexibility to capitalize on investment opportunities as well as life’s unpredictable events.