Diversification: Having Your Eggs in Different Baskets
Presented by ROBERT BLAKELY, CFP®, AIF®, CHFC®
We have all heard the saying, “Don’t put all of your eggs in one basket” which was coined in the early 1600s in Don Quixote by Miguel De Cervantes. When investing, particularly for long-term goals, there are two concepts you will likely hear about over and over again — diversification and asset allocation. Diversification is the art of not putting all your eggs in one basket and helps limit exposure to loss in any one investment or one type of investment. Asset allocation provides a blueprint to help guide your investment decisions. Understanding how the two work can help you put together a portfolio that targets your specific needs and keeps those eggs in different baskets.
After over 25 years in business at Blakely Financial, our team has seen the long-term benefits of diversification and firmly believe the following will help you in your long-term financial goals.
One way to lower your risk without sacrificing return potential is to spread your money out more widely. Diversification refers to the process of investing in a number of different investments to help manage risk. The theory is that if some investments in your portfolio decline in value, others may rise or hold steady.
For example, say you wanted to invest in stocks. Rather than investing in just domestic stocks, you could diversify your portfolio by investing in foreign stocks as well. Or you could choose to include the stocks of different size companies (small-cap, mid-cap, and/or large-cap stocks).
If your primary objective is to invest in bonds for income, you could choose both government and corporate bonds to potentially take advantage of their different risk/return profiles. You might also choose bonds of different maturities, because long-term bonds tend to react more dramatically to changes in interest rates than short-term bonds. As interest rates rise, bond prices typically fall.
Choosing different baskets for those ‘eggs’ is the key.
Asset allocation: Investing strategically
The second part of successful long-term investing is asset allocation. Asset allocation is a strategic approach to diversifying your portfolio among different asset classes that seeks to pursue the highest potential return within a certain level of risk. After carefully considering your investment goals, time horizon, and risk tolerance, you would then invest different percentages of your portfolio in targeted asset classes to pursue your goals. A careful analysis of these three personal factors can help you make strategic choices that are suitable for your needs.
Generally speaking, a large accumulation goal, a high tolerance for risk, and a long time horizon would typically translate into a more aggressive strategy and therefore a higher allocation to stock/growth investments. One example of an aggressive strategy is 70% stocks, 20% bonds, and 10% cash.
The opposite is also true: A small accumulation goal (or one geared more toward generating income), a low tolerance for risk, and a shorter time horizon might require a more conservative approach. An example of a more conservative, income-oriented strategy is 50% bonds, 30% stocks, and 20% cash.
Mutual funds and ETFs for Diversification
Because mutual funds and ETFs (Exchange Traded Funds) invest in a mix of securities chosen by a fund manager to pursue the fund’s stated objective, they can offer a certain level of “built-in” diversification. For this reason, mutual funds and ETFs may be an appropriate choice for most investors and their portfolios. Including a variety of mutual funds or ETFs with different objectives and securities in your portfolio will help diversify your holdings that much more. You can also select a combination of mutual funds to achieve your portfolio’s targeted asset allocation.
If you have accounts spread over multiple brokerage firms, think about consolidating. If you don’t have significant amounts of time, knowledge or desire to complete the research required for proper diversification, consider contacting a financial planning firm to assist with the decision process for proper diversification. Work with your chosen advisor to determine what steps need to be taken and if there are any exceptions to transferability. We cannot stress this enough for investors at or nearing retirement.
Rebalance to stay on target
Over time, an asset allocation can shift simply due to changing market performance. For example, in years when the stock market performs particularly well, a portfolio may become over-weighted in stocks. Or in years when bonds outperform, they may end up comprising a larger-than-desired percentage of the portfolio. In these situations, a little rebalancing may be in order.
There are two ways to rebalance. The first is by simply selling securities in the over-weighted asset class and directing the proceeds into the underweighted ones. The second method is by directing new investments into the underweighted asset class until the desired allocation is achieved.
Keep in mind that selling securities can result in a taxable event unless they are held in a tax-advantaged account, such as an employer-sponsored retirement plan or an IRA so make sure you plan accordingly and consult with your financial advisor with any questions.
By planning appropriately and diversifying your portfolio with a specific asset allocation based on your investment objectives, you can pursue your financial planning goals with more confidence. And just remember, don’t put all your eggs in one basket.
Engage with the entire Blakely Financial team at WWW.BLAKELYFINANCIAL.COM to see what other expert advice we can provide towards your financial well-being.
ROBERT BLAKELY, CFP® is a financial advisor with BLAKELY FINANCIAL, INC. located at 1022 Hutton Ln., Suite 109, High Point, NC 27262. He is the founder and president of Blakely Financial, Inc.
Blakely Financial, Inc. is an independent financial planning and investment management firm that provides clarity, insight, and guidance to help our clients attain their financial goals.
Securities and advisory services offered through Commonwealth Financial Network, Member FINRA/SIPC, a Registered Investment Adviser.
Diversification and asset allocation programs do not assure a profit or protect against loss in declining markets, and cannot guarantee that any objective or goal will be achieved.