For establishing a strategy that tempers potential losses in a bear market, the investment community preaches the same thing that the real estate market preaches for buying a house: "location, location, location."
What Is Diversification?
Diversification is a battle cry for many financial planners, fund managers, and individual investors alike. When the market is booming, it seems almost impossible to sell a stock for any less than the price at which you bought it. When the indexes are on their way up, it may seem foolish to be in anything but equities. But because we can never be sure of what the market will do at any moment, we cannot forget the importance of a well-diversified portfolio (in any market condition).
Diversifying Your Portfolio: 5 Easy Steps
Learning to Practice Disciplined Investing
With the luxury of hindsight, we can sit back and critique the gyrations and reactions of the markets as they began to stumble after the 1990s, and again in 2007. Diversification is not a new concept.
We should remember that investing is an art form, not a knee-jerk reaction, so the time to practice disciplined investing with a diversified portfolio is before diversification becomes a necessity. By the time an average investor "reacts" to the market, 80% of the damage is done. Here, more than most places, a good offense is your best defense and in general, a well-diversified portfolio combined with an investment horizon of three to five years can weather most storms.
Here are five tips for helping you with diversification:
1. Spread the Wealth
Equities can be wonderful, but don't put all of your money in one stock or one sector. Consider creating your own virtual mutual fund by investing in a handful of companies you know, trust, and perhaps even use in your day-to-day life.
People will argue that investing in what you know will leave the average investor too heavily retail-oriented, but knowing a company or using its goods and services can be a healthy and wholesome approach to this sector.
2. Consider Index or Bond Funds
You may want to consider adding index funds or fixed-income funds to the mix. Investing in securities that track various indexes make a wonderful long-term diversification investment for your portfolio. By adding some fixed-income solutions, you are further hedging your portfolio against market volatility and uncertainty.
For more, see: Why It Pays to Be a Lazy Investor.
3. Keep Building Your Portfolio
Add to your investments on a regular basis. Lump-sum investing may be a sucker's bet. If you have $10,000 to invest, use dollar-cost averaging. This approach is used to help smooth out the peaks and valleys created by market volatility. With dollar-cost averaging, you invest money on a regular basis into a specified portfolio of securities.
4. Know When to Get Out
Buying and holding and dollar-cost averaging are sound strategies, but just because you have your investments on autopilot does not mean you should ignore the forces at work. Stay current with your investments and stay abreast of any changes in overall market conditions. You'll want to know what is happening to the companies you invest in.
5. Keep a Watchful Eye on Commissions
If you are not the trading type, understand what you are getting for the fees you are paying. Some firms charge a monthly fee, while others charge transactional fees. Be aware of what you are paying and what you are getting for it. Remember, the cheapest choice is not always the best.
The Bottom Line
Investing can and should be fun. It can be educational, informative and rewarding. By taking a disciplined approach and using diversification, buy-and-hold and dollar-cost-averaging strategies, you may find investing rewarding even in the worst of times.