The Financial Advantages of Diversification
By Marjorie L. Rand, CPA, CFP®, RICP®
Investing your money is a pivotal step in the direction of a successful financial future and realizing your money goals. Whether you’re working toward retirement, homeownership, or establishing an emergency fund, investing serves as an effective means to nurture your wealth over time. However, entrusting your financial future to one sole investment strategy can prove risky. This is precisely where the concept of diversification enters the picture.
Diversifying your investment portfolio is a fundamental strategy for mitigating risk, optimizing returns, and attaining your financial objectives. By distributing your investments across various assets, you not only decrease your overall investment risk but also increase the potential for returns and enduring financial stability. Let’s explore three advantages of diversifying your investment portfolio and how it can pave the way to reaching your financial goals.
Minimize Risk
One primary role of diversification is to minimize risk in the stock market. This doesn’t just mean diversifying between growth stocks and value stocks. True diversification requires incorporating a mix of different types of investments—think stocks, bonds, international investments, real estate, etc.
There are varying factors that govern the amount of risk you’re willing to accept. If you are banking on your money being there for you on a certain date, it may align better with your financial plan to utilize a more conservative mix of investment assets with a history of lower volatility. Having a portfolio that is diversified with lower risk will give you peace of mind.
As we mix and match asset classes and strategies, risk-capacity decisions need to be made no matter the timeline length. By optimizing the way your portfolio is constructed, we can help minimize risk.
Increase Your Potential for Added Gains
Learning a bit of stock market history often puts many at ease when deciding to move money from a savings account into the stock market.
Downturns and recessions are certain realities during one’s lifetime, but those are the same reasons why many wealth managers suggest taking a long-term view on investing. Simply keeping your money in the stock market versus quickly buying and selling is a risk-mitigation strategy of its own.
These downturns also pose new opportunities. Take the global pandemic, for example: 2020 created a unique window of opportunity. Certain high-growth investments performed exceptionally well as the economy reacted to COVID-19, while the brief drop in the market made some value investments available at deeply discounted prices. 2020 provides an example of how investments respond differently to economy-wide shifts, which underscores the importance of diversification as a hedge against both short and long-term losses.
Because of the unpredictability associated with short-term stock market success, diversification and investing according to when you need the money can help you reach your goal with more confidence when compared to putting all your eggs into one basket.
The Ideal Mix
Perfection is notoriously unattainable, so calling an investment mix “ideal” can feel like a loaded term. Everyone has their own unique goals, dreams, timelines, and risk capacity—what’s ideal for one may not be ideal for another. In general, the closer you are to retirement, the more conservative investment mix you might hold. Remember that portfolios can change with time; that’s the beauty of the stock market—you can change your portfolio as your goals evolve.
A Thoughtful Approach to Strategy
While the idea of spreading your investments around may be straightforward, actually doing it the right way can be a bit complex. That’s why teaming up with an advisor who knows your financial story and goals is important for making your investments successful.
At Rand Financial Planning, our main mission is to help you plan your finances strategically so you can experience the future you’ve always wanted. If you’re thinking about diversifying your investments or just want to review your money plan, we’re here and ready to chat. Schedule a 20-minute introductory call or reach out to me at 908-895-2406 or marge@randfinancialplanning.com to see if I’m the right fit to help you on your financial journey.