Now that you are ready to invest for your retirement, it is important to understand where to invest. Each type of investment has distinct advantages and disadvantages, and because each tends to behave differently in different types of economic mood swings, any long-term investor’s portfolio should be broadly diversified.
In an investment climate as ugly as the one we’re in today, it is easy to believe that your specific investment choices don’t really matter. This is partly due to the fact almost all asset classes went down during 2008. Still, eventually markets will recover. How far, and how fast, are questions that no one can predict.
“Don’t put all your eggs in one basket”
– An Old Saying
As the manager of your portfolio, you too need to understand the importance of diversification. There will be periods when some of your holdings will lose money. When that occurs, you need other investments to offset the decline.
One form of diversification is asset allocation. By having elements of different investment classes in your portfolio – including stocks, bonds, cash, real estate, gold or other commodities – you can protect your portfolio from losing the value that it might if it only contained one failing asset category.
When stock prices fell last year, for example, gold prices rose to a new all time high. Often when stock prices fall, bond and debt market deliver better performance because investors move their money into what is considered a less risky investment. So a portfolio that included stocks, bonds, and gold would perform differently than one that included only stocks, only bonds or only gold.
Investors can choose from a number of financial tools to gain exposure to the broadest investment classes – stocks, bonds, cash, properties, gold.
It’s also wise to diversify within asset classes. Investors who loaded up on tech stocks in 2000 lost their shirts when the dot.com bubble burst and technology shares rapidly fell out of favor. Similarly, financial stocks were hammered down in early 2008 due to the global financial crisis and some exposure to the subprime mortgage crisis.
So the two steps to diversification are to spread your money among different asset categories, then further allocate those funds within each category. A smart approach for a retail individual investor is to diversify using mutual funds.
By diversifying your portfolio, you’ll give yourself an opportunity to grow your money despite the ups and downs that comes with investing.