Diversifying your investments is one of the most brilliant things you can do to ensure that you are maximizing your gains, minimizing risk, and getting the best return on your money.
There are three types of investments—stocks, bonds, and cash equivalents. Stocks are shares in a company that gives you ownership over part of the company’s assets or earnings stream. On the other hand, bonds are loan agreements where investors lend money to companies or governments with an understanding to be paid interest until they’re repaid. Lastly, cash equivalents include anything with similar qualities as cash— savings accounts, certificates of deposit (CDs), etc.
These three investment vehicles each have their risks associated with them, so any investor needs to hedge these risks by diversifying their holdings.
Use a Diversified Approach to Investing as Your Standard Strategy
By definition, diversification is the practice of investing across different types of securities to reduce volatility. This means that you should have fingers in many pies i.e., spread your investments across stocks, bonds, and cash equivalents. You don’t want all your eggs in one basket.
There are many investment strategies, but a diversified approach to investing is the best way for any beginner to invest their money. By adding other assets, it can help smooth out volatility and returns over time
Build a Mix of High-risk, Medium-risk, and Low-risk Investments
Investment management companies often suggest that diversifying your investments is the best way to maximize your returns while minimizing risk. However, what does this mean exactly? This means that you should take an approach where stocks are the high-risk investment, bonds are the medium-risk investment, and cash equivalents or bonds (if you’re not comfortable investing in anything else) are the low-risk investment.
Examine the stock’s qualitative risk before investing
Is the company in a volatile industry? Is it new to the market with a bit of a track record of success?
If you’re not comfortable investing in anything else, look carefully at your bond holdings. Are you invested in bonds for corporations or governments? What is their credit rating? Do they have high yield potential with low-risk returns?
As previously mentioned, take an approach where stocks are the high-risk investment, bonds are the medium-risk investment, and cash equivalents or bonds are the low-risk investment.
For example, you can split your money evenly across three separate funds—one for each type of investment i.e., a stock fund, a bond fund, and a cash equivalent or bond fund. This means that if one of your investments does poorly, it will have less impact on your overall portfolio because you have other types of investments to balance the losses.
Invest in bonds with regular cash flows
In addition, you can simply split your money across different types of bonds and make systematic investments every month. This way, if one kind of bond does poorly, you still have another source of income and capital gains that won’t be as severely affected.
For example, you can allot 25% to corporate or government bonds with high yield potential but low risk, 25% to corporate or government bonds with low yield but high safety, and 50% to cash equivalents or bonds (savings accounts, CDs, etc.)
Follow a buy-hold strategy for better profits
You can split up your money into stocks and then take a buy-hold strategy. A buy-hold approach means that you simply continue to invest in the same companies as long as they’re performing well enough to keep them in your portfolio.
This is a promising approach since many of your investments will be winners, and those profits will outweigh the losses from the stocks that may have performed poorly.
If your investments are performing poorly, take a buy-hold approach to buy new stocks with newer gains instead of pulling out of them completely.
Explore global markets
If you’re not limited to investments within your country, you can also explore different marketplaces like the United States and Europe. This way, you’ll be able to diversify even further and find more opportunities for gains and losses that will offset each other.
Rebalance your portfolio
It’s critical to check your investment portfolio regularly to ensure that the various assets have appropriate balances. The goal of this review should be to assess how far you’ve come and where you’ve been since your last evaluation.
A financial counselor can assist you in assessing your assets in light of your lifestyle and advise you on other viable alternatives. By keeping track of your portfolio’s growth over time, you’ll be more disciplined about investing and more aware of its long-term gains. These two aspects will eventually aid you in making better judgments and gaining a deeper understanding of investments going forward.
It is essential to diversify your investment portfolio by investing across several financial instruments, including cash equivalents, stocks, and bonds. You can also diversify based on the type of bonds, the industry sectors you trade in, and your monthly systematic investments (if you plan to invest this way).
Diversification not only helps maximize returns while minimizing risk but also reduces volatility and keeps your portfolio balanced.