This is the sixth installment in an eight-part series: Navigating Market Volatility. In simple terms, market volatility is the relative rate at which the market goes up and down. Dramatic shifts can be scary, even for the most experienced investors. To keep market swings from making you anxious, take steps to help you respond to volatility in a deliberate way.
To read the previous post in this series click here.
Navigating Market Volatility: Diversify
You’ve probably heard it a million times—diversify, diversify, diversify. To diversify your portfolio simply means to invest in a variety of securities, with the hope that positive performance of some investments will offset any negative performance in others. The goal of diversification is to build a portfolio that includes investments that react differently to the same economic factors, limiting the risks associated with “putting all your eggs in one basket.”
When building your portfolio, there are three main asset classes from which to choose: stocks, bonds and cash equivalents. Each asset class has its own level of risk and return. Equities, for example, may offer not only the highest potential return but also the highest risk. On the other hand, Treasury bills are considered to be one of the least risky investments (because they are backed by the U. S. government), but they also generally offer low potential returns.
Beyond just assets classes, you can diversify even further by allocating your money to different subclasses. For example, within the stock category you can choose investments based on various market capitalizations: large companies, mid-sized companies and small companies. You might also include securities issued by companies that represent different economic sectors. If you’re buying fixed income securities, you might choose bonds from different types of issuers: corporations, the U.S. government, etc. When determining your optimal asset mix, remember your investment objectives, time horizon, available capital and tolerance for risk.
Many retail investors have a limited investment budget, sometimes making it difficult for them to put together a diversified portfolio on their own. Buying shares of a mutual fund can provide a readily available source of diversification.
Click to read Part 7 of the series: Don’t Try to Time the Market
All investments are subject to risk, including the possible loss of the money you invest. Past performance does not guarantee future results. There is no guarantee that any particular asset allocation, or mix of funds, or any particular mutual fund, will meet your investment objectives or provide you with a given level of income.