Steps to Build a Diversified Portfolio

Introduction

A diversified portfolio is an investment approach that utilizes a combination of asset classes, such as stocks, bonds, and cash, to create an optimal balance of risk and return. While there is no one-size-fits-all approach to portfolio diversification, understanding the key principles of diversified investing and the types of investments that can be used is the key to getting started.

Benefits of Diversified Portfolios

• Helps to reduce volatility.
• Can help increase returns over the long term.
• Provides an opportunity to spread risk.
• Increases resiliency during times of market crisis.

Do An Assessment of Your Current Portfolio

Assessing your current portfolio is an essential step towards building a diversified one. This will allow you to identify your risk comfort level as well as better understand what investments you currently own. It will also help you to set goals for yourself as you build your portfolio.

Determine Your Risk Comfort Level

Before you can begin assessing your portfolio, it is important to determine how much risk you are comfortable taking. Low risk portfolios invest in stable investments, such as bonds and cash, and high risk portfolios may invest in stocks and other more volatile investments. Knowing your risk comfort level will help you better understand the investments you are considering.

Evaluate Your Current Investments

Once you have determined your risk comfort level, it’s time to evaluate your current investments. Take an inventory of the investments you own and note the type of investment (such as stocks, bonds, mutual funds, etc.), the amount of money you have invested in each investment, and the performance of each investment. This will give you an overview of your current portfolio.

Set Your Goals

Now that you have seen a snapshot of your portfolio, it is time to set goals for yourself. Think about what kind of returns you are hoping to make and how quickly you want to reach them. Also consider the types of investments you want to focus on and how much risk you are willing to take. This will help to provide guidance for you as you build a diversified portfolio.

• Determine your risk comfort level.
• Evaluate your current investments.
• Set your goals.

Determine the Types of Assets to Include

When determining the types of assets to include in your diverse portfolio, there are several factors to consider. Equities, fixed income assets, commodities, and estate planning assets are all important components of a diversified portfolio. Let’s take a closer look at each of these asset types.

Equities

Equities, or stocks, are a good choice for long-term growth-oriented investors. Equities represent ownership in a company and typically have a higher risk-reward profile than fixed income assets. If you’re looking to build a diversified portfolio with an emphasis on long-term appreciation, stocks are likely a suitable choice.

Fixed Income Assets

Fixed income assets, such as bonds, are seen as a less risky option than equities. They typically pay regular interest payments, and they are typically used by investors looking for stability and income. This type of asset is a good choice for those who are focused on the preservation of capital.

Commodities

Commodities represent a different kind of asset class and can offer a good hedge against inflation. Gold, silver, and oil are common examples of commodities that can be included in a diversified portfolio. Including a mix of such assets can provide an added layer of protection to your investment portfolio.

Estate Planning Assets

Estate planning assets should also be considered when building a diversified portfolio. These assets typically have a longer-term investment horizon, and they are often focused on tax minimization. Examples include life insurance policies and trust funds.

Balance Your Portfolio

In order to build a well diversified portfolio, it is critical to ensure that your investments are balanced. By diversifying your investments across different asset classes, sectors, and investment vehicles, you become less susceptible to fluctuations in the market and are more likely to realize positive returns over time.

Use a Ratio of Asset Classes

Asset classes refer to the broad categories into which all assets can be divided, such as stocks, bonds, cash, and real estate. A well-thought-out asset allocation strategy should include a mix of these classes that is tailored to meet your financial goals and risk tolerance. A general rule of thumb is to create a portfolio that consists of 60% stocks and 40% bonds, with the remainder invested in alternative asset classes such as cash or real estate.

Consider Investing in Different Sectors

In addition to diversifying across asset classes, it is also important to consider diversifying across different sectors of the economy. Investing in a broad range of industries can help to reduce volatility and ensure that you are not overly exposed to any individual sector. Popular sectors to consider investing in include technology, consumer discretionary, health care, and industrials.

Use Different Investment Vehicles

In addition to diversifying across asset classes and sectors, it is also important to diversify your investments across different types of investment vehicles. Different vehicles have varying levels of risk and reward, and thus it is important to understand the pros and cons of each before committing your money. Popular investment vehicles include mutual funds, exchange traded funds (ETFs), individual stocks and bonds, and real estate investment trusts (REITs).

By having a well balanced portfolio, investors are able to reduce their investments' exposure to risk while still maintaining the potential to generate returns. By following the steps outlined here, investors can create a portfolio that is diversified across asset classes, sectors, and investment vehicles and thus is better-positioned to withstand market volatility.

Implement Risk Management

Building a diversified portfolio is a critical step to securing your financial future. A key part of this process is implementing an effective risk management strategy, which is designed to minimize your exposure to loss over time and avoid costly mistakes. Here are some ways to help you manage your risk and ensure you are adequately protected:

Set Contribution Limits

Before you start investing, you should set limits on how much money you can contribute to your portfolio each month. This will help you stay within your budget and prevent you from over investing in any single security or asset class. It’s important to keep these limits in mind when selecting investments for your portfolio, as you don’t want to overexpose yourself to the market and its fluctuations.

Utilize Stop Loss Levels

One of the most important steps to take when building a diversified portfolio is to establish stop loss levels. A stop loss is an order that will be placed with a broker to automatically sell a security at a certain price. This is an important tool to help manage risk, as it will automatically sell off a position when it reaches a preset price, preventing further losses. It’s important to set these levels carefully, as they will determine when you decide to liquidate a security.

Monitor Your Investments

The last step in managing risk is to monitor your investments closely. This can be done by keeping up with news, reading financial publications, and regularly checking in on your portfolio. By staying on top of the market, you can better stay aware of any potential risks or issues with your investments. Additionally, it is also important to regularly rebalance your portfolio to ensure you are taking advantage of changing market conditions.

• Set contribution limits
• Utilize stop loss levels
• Monitor your investments

Rebalance Periodically

Rebalancing your portfolio periodically is a vital part of achieving a diversified portfolio. A regular review routine allows you to assess how your asset allocation strategy is working, and if needed, make corrections to ensure your holdings remain aligned with your long-term goals. Rebalancing involves buying and selling securities within your portfolio in order to keep asset classes at their target allocations.

Maintain Appropriate Allocations

When you review your portfolio, it’s important to ensure you have a balanced mix of assets. Rebalancing allows you to maintain asset allocations that reflect the amount of risk you’re willing to take while staying consistent with your financial goals. For example, if you planned to evenly allocate 40% of your portfolio to stocks and 40% to bonds, but stocks have grown in value during the period since you last rebalanced, you might decide to sell some stock and buy bonds to bring the ratio closer to your target allocation.

Adapt to Changes in the Market

Rebalancing also allows you to capitalize on market movements. Because stocks and bonds typically don’t move in the same direction, rebalancing will enable you to adjust your portfolio to capitalize on potential investment opportunities. For example, you could decide to add to a position that has outperformed the market, or reduce a position that has underperformed.

Reallocate for Tax Purposes

Finally, you can use rebalancing to generate tax benefits. When you choose to sell profitable investments to rebalance your portfolio, you may be able to incur fewer taxes than if you would have sold the same investments outside of rebalancing. Also, if you are getting ready to sell an investment outside of a rebalancing strategy, you may use rebalancing to reduce or eliminate the taxable gains.

Conclusion

Building a diversified portfolio is an important and necessary step in achieving your investment goals. It is important to understand the investment options available and the steps to build and manage a diversified portfolio. By considering the different asset classes, evaluating and selecting the right asset mix, rebalancing the portfolio, and establishing a regular review process, you can create a portfolio that helps you meet your investment goals over time.

a. Diversifying Your Portfolio is an Important Step

Creating a diversified portfolio is important, as it helps to reduce the risk of investing in just one or two securities. By diversifying your investments, you can take advantage of the different asset classes and types of securities available, allowing you to select the best mix of investments for your specific goals and objectives.

b. Periodic Reviews Help Achieves Your Investment Goals

Finally, it is important to establish a regular review process for your portfolio. By monitoring the performance of your investments and rebalancing your portfolio, as needed, you can ensure that your portfolio is on track to meet your investment goals.

Building and maintaining a diversified portfolio takes time, effort and knowledge. It is important to do the necessary research and consult with an experienced financial professional to ensure that you are taking the right steps to meet you investment goals.