What Is the Benefit of Diversification in Your Investments?

Odds are that if you’re investing it’s because you’re trying to meet a major financial goal like having enough money for retirement, saving for college, or starting a …

Alternative Investments

Odds are that if you’re investing it’s because you’re trying to meet a major financial goal like having enough money for retirement, saving for college, or starting a business. Most investment beginners are only familiar with the stock market, and stocks can be a great way to make money. They tend to offer higher returns compared to most other investment options over time, and they’re relatively easy to understand. You’ll take on greater risks if you put all your trust in the stock market compared to someone with a diversified portfolio, however.

If you’re a newcomer, you’ll probably wonder why is diversification important in investing? Diversification is important to reduce your long term financial risk. It isn’t just about investing in a bunch of different stocks from different companies either. For a truly diversified portfolio, you’ll need to invest in different industries, financial instruments, and different asset classes. Investing everything into a stock portfolio makes you vulnerable to the volatile nature of stocks. It’s impossible to predict the behavior of the market, and you may lose much of your investment portfolio if there is a particularly bad downturn. Here are some different investments you can consider to lower risk.

Asset Allocation Funds

These funds are popular with modern investors because they offer built-in diversification. Asset allocation funds are made up of a variety of asset classes, and they come in a few basic types. Perhaps the most common is the balanced fund, a mutual fund that typically combines stocks and bonds. Unlike stock prices, which fluctuate frequently, bonds offer fixed interest rates and are generally considered low investment risks. A 60/40 mix of stocks and bonds is the most popular, but you can generally customize your funds how you like.

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There are also target-date funds, which are long term investments, and these are meant to build upon assets over a specified period of time (the target date). These portfolios generally have higher risk tolerance and will, therefore, be made up partly of more speculative higher return assets with a percentage of safer ones to offset the risk.

Real Estate

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This may seem intimidating to new investors, but investing in real estate doesn’t have to be complicated, and there are two great options for the public. The first is a real estate fund, which is a type of mutual fund that invests in income securities from properties in exchange for repayment with interest.

There are also real estate investment trusts, which are companies that own income-producing properties like stores, warehouses, or rental properties. Payouts from REITs can come from collected rent, mortgage payments, or a combination of the two. They’re popular investment options largely because 90% of their taxable income is returned to shareholders every year, meaning REITs can offer greater payouts compared to other real estate options.

Hedge Funds

A hedge fund is a type of pooled investment, meaning that multiple individual investors invest in it, that’s overseen by an investment advisor. They get their name from the fact that they’re generally made up of short term and long term investments, a strategy meant to “hedge” financial risk. These funds can work with a variety of assets and take many different approaches. The important thing is that the investors and the advisor agree on the strategies that are to be used.

Managers of hedge funds will charge a percentage of the profits for their financial services, and investors must be accredited to participate. Accredited investors are usually business entities, but an individual who makes an income annual of $200,000 or more may qualify. These funds are generally for already successful investors who are looking to diversify further.

Regardless of how you go about it, it’s impossible to overstate the importance of diversification to your overall financial health.

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