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Is my portfolio diversified enough?
To offer both security and high returns, your investment portfolio must meet certain very specific criteria. Below is a review of the main guidelines for sound investment management.
The notion of diversification follows a well-known rule: don't put all your eggs in one basket. As a matter of fact, it's very easy to have a well-diversified investment portfolio given the variety of on the market. But how should you go about it? There are a number of ways to diversify an investment portfolio. Here are the main ones:
The first–and by far the most important–way to diversify an investment portfolio is to divide it among the three main categories of assets. The money market, which involves no risk but has very low returns; fixed-income securities (especially marketable bonds), which entails moderate risk but can have attractive returns; and stocks, which come with a high risk but the hope of greater returns. A number of studies have shown that a portfolio's expected rate of return depends to a very large degree (up to 85%) on the amount invested in each category of assets, regardless of the types of securities chosen (bonds, stock, etc.). Diversify this way, and you'll be almost home free.
Nonetheless, other types of diversification should not be ignored. For marketable bonds, you can vary maturity dates. Your portfolio should include bonds that mature in a few years (because they are less affected by interest rate fluctuations) and others that mature further down the line. These longer term bonds have a higher short-term risk, but can provide attractive profits in the event of a drop in interest rates.
As for stocks, there are several types of diversification: geographic (by country), sectoral (by field of business), and management style (growth or income-focused). Each of these diversification methods has its place in a well-managed portfolio.
One very simple way to instantly diversify your portfolio is to obtain all your securities through an investment fund. As this type of fund contains securities with varied maturity dates (for bond funds) or that come from a number of companies (for equity funds), it is a diversified portfolio in and of itself. This is particularly the case with balanced funds, which include money market securities, bonds with various maturity dates, and domestic and foreign stocks.
This way you don't need to hold a large number of different funds to have a well-diversified portfolio. For the average investor-up to about $200,000-three or four really different funds should do the trick. Avoid overdiversifying!
You want to be sure your portfolio is sufficiently diversified and corresponds with your investor profile? Contact your work financial advisor who can give you more information on this topic.