Diversification, with an emphasis on a variety of investment types, is one of the ways smart portfolio managers like Mark J. Leder minimize risk and maximize returns for clients. The correct strategy is to leverage the potential strength of various small and large asset classes, which will each have different times when they do well. For example, there are times when small company stocks beat the returns of larger, companies. And there are times when real estate beats them both.
When you diversify, you aim to manage risk by spreading out your investments. You might pick investments based on different market caps: some large companies or funds that invest in large companies, some mid-sized, and some small companies. You might also aim for companies or funds focused on different sectors of the economy, including technology, infrastructure or manufacturing.
In the same way, when purchasing bonds, you would choose between federal government, state and local governments and corporations and aim for a mix that would have different terms and credit ratings. But one must be aware of the factors that affect these types of investments. And when buying bonds that have different terms and maturity dates, you need to educate yourself to the pros and cons. The objective should always be to invest amounts in short-term and long-term bonds based on your desire for capital returns and appetite for risk.
Rounding out your portfolio with other investments including real estate, whether through direct investment or through a REIT, is a good idea because real estate historically has been a great hedge, and can save you when other investments get shaky. Finally, look into investing overseas and in emerging markets, which often show the best returns, but at the highest risk. If you have the appetite and the stomach, you can potentially do very well in this area. But again, do your homework and seek out expert advice.
Can You Over Diversify?
The best answer is that unfortunately this is a complicated question, and will vary based on your individual goals and needs. Building a diversified portfolio is often why many investors buy so many different types of investment funds. These investments include a large number and variety of underlying investments, so they spread out risk. You do have to make sure, however, that even the pooled investments you own are diversified. For example, owning two mutual funds that invest in the same subclass of stocks won’t help you to diversify.
Every investment approach should consider broad asset allocation, and there should be enough diversification to create a broad portfolio of investments. And, you must actively monitor your investment choices and be prepared to change either an individual investment or investment strategy, if the one you have does not meet your goals. Be ready to make adjustments, sell investments and invest in new ones, when the situation calls for it.