The Benefits of Having a Diverse Portfolio

Investors have become increasingly concerned about a potential slowdown or recession in the months ahead. While no one can predict with accuracy when specific market or economic events may occur, we know that a downturn can and may occur, due in part to the cyclical nature of the markets and economy. That makes it important for investors to take steps to ensure their portfolios are positioned to weather storms that may come their way. Diversification is a powerful tool investors have to help them accomplish this goal.

Diversification is the process of spreading assets across multiple investment types and asset classes to help limit exposure to any one asset that might fluctuate downward. The goal is to seek growth while managing the "downside" in portfolios. However, simply investing in several different funds or asset classes doesn’t necessarily constitute a well-diversified portfolio. Broad diversification takes many factors into consideration, including concentration risk - or having too much of your portfolio in one kind of investment - and the correlation between markets and investments. As a result, it can be difficult for individual investors to achieve the same level of diversification found in professionally managed investment portfolios.

The role of diversification in managing risk and return
To effectively manage risk and return, professional managers - like financial advisors - seek to spread portfolio assets across a broad mix of securities. Depending on a portfolio’s objectives, these may include stocks of small, midsize and large companies; U.S.-based and international equities/bonds; short, intermediate and long-term bonds. Additional investment considerations may include real estate and other alternative investments, as appropriate for an investor’s age, objectives, risk tolerance, and timeline.

Diversification reduces concentration risk, which is the potential for outsized losses when a large portion of an investor’s holdings are invested in a single investment, asset class, or market segment. For example, if you’re only invested in technology stocks and that sector experiences a significant downturn, you could see a commensurate loss in portfolio value. On the other hand, if you hold investments in many different asset classes and sectors, investments that are performing well could help buoy your overall portfolio value.

Correlation is the degree to which different securities, asset classes, or markets move in relation to one another. Allocating money to different asset classes with low or no correlation can help reduce portfolio volatility. That’s because when one investment or asset class is doing poorly, others may be performing well, helping to smooth out volatility and returns. It’s important to remember that investing involves risk and diversification alone cannot guarantee returns or protect against investment losses.

To learn more about strategies for managing risk and return in any investment climate, call my office to schedule a time to talk or select a time from our calendar at www.calendly.com/kfn.