One thing even new investors understand is the concept of diversification, or the blending of 澳洲幸运5官方开奖结果体彩网:asset classes to reduce risk. But even with a well-diversified stock portfolio, an individual is still exposed to 澳洲幸运5官方开奖结果体彩网:market risk (or 澳洲幸运5官方开奖结果体彩网:systematic risk), which cannot b๊e reduced by adding additional stocks.

Below, we discuss the principles of diversification and how investors can build a truly diversified 澳洲幸运5官方开奖结果体彩网:portfolio.

What Exactly Is Diversification?

Diversification works by spreading your investments among a variety of asset classes (such as stocks, bonds, cash, Treasury bills or T-bills, real estate, etc.) that have a low 澳洲幸运5官方开奖结果体彩网:correlation to each other. Low correlation reduces 澳洲幸运5官方开奖结果体彩网:volatility. The assets rise and fall in price at different times, at different rates, and based on a variety of factors. A portfolio holding diversified assets helps to create more c🔥onsistency and improve overall performance.

How Does Correlation Work?

Correlation is simple: If two asset classes are perfectly correlated, they are said to have a correlation of +1. This means that they move in lockstep with each other, either up or down.

A completely random correlation—a relationship in which one asset’s chance of rising is equal to the chance of it dropping if the other asset rises or falls—has a correlation of 0.

If two asset classes move in exact opposition—for every uptick in one asset, there is an equal downtick in the other, and vice versa—they are negatively correlated, or have a correlation of -1.

Diversified Stock Portfolio𓆏 vs. Diversified Portfolio of Assets

When we talk about the 澳洲幸运5官方开奖结果体彩网:importance of diversification in a stock portfolio, we’re referring to an investor’s attempt to reduce exposure to 澳洲幸运5官方开奖结果体彩网:unsystematic risk (i.e., company-specific risk) by investing in various companies across different sectors, industries, or even countries. A diversified stock portfolio contains a broad variety of stocks, but it is still focused o😼n that single asset ౠclass.

When we discuss diversification among asset classes, the same concept applies but over a broader range. By diversifying holdings across different asset classes, the investor reduces exposure to the 澳洲幸运5官方开奖结果体彩网:systemic risk of any one asset class. Thus, if a market crash sends all o🎶f the prices of the stocks in the portfolio tumbling, other uncorrelated assets may not lose value at the same time, providing additional stability.

Like holding a single company in your stock portfolio, having your entire 澳洲幸运5官方开奖结果体彩网:net worth in a portfolio of any one asset (even if that portfolio is diversified) constitutes putting all of your eggs in one basket. You are still very much exposed to market risk. By investing in a broad number of assets, you reduce exposure to market risk or 🔴the systemic risk of any one asset class.

🍰Although diversification is no guarantee against losses, investing professionals see this as a prudent long-range strategy.

How to Diversify Your Portfolio

Fixed-Interest Investments

Bonds are a popular way to diversify due to their low correlation with other major asset classes, particularly equities. Other fixed-interest investments such as 澳洲幸运5官方开奖结果体彩网:Treasury bills (T-bills), 澳洲幸运5官方开奖结果体彩网:bankers’ acceptances, and 澳洲幸运5官方开奖结果体彩网:certificates of deposit (CD) are also 🔥popular. Investors typically view these asset classes as less prone to risk co🌺mpared with stocks. Conversely, they may also provide lower returns.

Real Estate

Another option is 澳洲幸运5官方开奖结果体彩网:real estate, which has a relatively low correlation with stocks. 澳洲幸运5官方开奖结果体彩网:Adding some rꦆeal estate to your portfolio is a♊ practical way to diversify, largely because many people (through homeownersꦑhip) are invested in the real estate market.

It’s amazing how often investors overlook the potential of real estate. Investing in real estate doesn’t require purchasing a house or building. 澳洲幸运5官方开奖结果体彩网:Real estat🐟e investment trusꦉts (REITs) provide an easy and less expensive alternative to buying property directly. REITs tr🐼ade like stocks on the major exchanges. They invest directly in property and mortgages and typically offer high yields. Because real estate has a relatively low correlation with stocks, inv𒁃esting in REITs is a good way to diversify away from equities.

Safe Haven Assets

So-called 澳洲幸运5官方开奖结果体彩网:safe haven assets are those specifically utilized to provide stability to a portfolio during times of market turmoil. While some of the assets listed above can be safe havens, the iconic safe haven asset is gold. Gold (and other 澳洲幸运5官方开奖结果体彩网:precious metals) are 澳洲幸运5官方开奖结果体彩网:stores of value that are not subject to issues related to interest rates. Although some investors may 澳洲幸运5官方开奖结果体彩网:debate the value of gold as a safe haven, it has tended historically to maintain its value over time. This means that it can be a hedge against inflation and adverse m♕arket conditions.

Currencies

Currencies can be an important part of a diversification strategy. In some ways, cash is the ultimate safe haven asset. However, it is generally not advisable to hold cash over a long period, as it provides little by way of yield or return and is negatively impacted by 澳洲幸运5官方开奖结果体彩网:inflation.

The Bottom Line

Diversification is a key building block to 澳洲幸运5官方开奖结果体彩网:anyone’s financial plan, including understand♈ing what di☂versification does and how it helps an individual’s overall financial position. It is crucial that investors know the difference between systematic and unsystematic risk, as well as understand that by diversifying among asset classes, they can mitigate exposure to systematic risk.