Most personal finance experts recommend that their audiences diversify their investments, and those with limited funds to invest might wonder how to diversify. There are a few options that can help with diversification.
It’s first important to answer the question of why it’s important to diversify. Those who throw all of their money toward a single stock or a single rental property can find themselves broke if a company declares bankruptcy or a neighborhood goes downhill rapidly. That’s why it’s important to spread investment dollars around to a number of intelligent investment options. If one asset fails, the others should allow an investor to stay afloat.
Diversify In One Asset Class
Those who are looking to diversify might decide it’s a good idea to hold a number of investments in a single asset class. This might be shares from several different companies. It might involve a range of municipal bonds. A portfolio of rental properties can also provide diversification. One simple way to diversify investments in stocks and bonds is investing through mutual funds or ETFs. These are effectively baskets of a number of individual stocks or bonds. Mutual funds and ETFs can be relatively passive investments that require no management on the part of an investor. However, because these funds hold several dozen or a few hundred issues, they are unlikely to see a massive decline in value if one or two lag the broader market.
Diversify Across Asset Classes
It’s also possible to diversify across asset classes. Holding all investments in stocks when the stock market is down can lead to a serious decline in net worth. Therefore, it can pay to own real estate while owning stocks or bonds. At times, the stock market might be down while home prices are increasing. This increase in one asset should offset the decrease in the value of the other. Some people invest in precious metals because they tend to maintain their value or increase when other asset classes are declining in value. Diversifying across asset classes is a great way to mitigate a steep decline in one asset class. This cuts down on the volatility that can come with the ups and downs of the stock market or the real estate market and help investors sleep a little better at night.