Diversification, the backbone of modern portfolio theory, is now almost a rule of thumb in the investing world. This concept, however, wasn’t always as widely practiced as it is now. In fact, Harry Markowitz and the rest of the team that developed the concept during the 1950’s went on to win a Nobel prize for the idea in 1990.
The concept is simple: if you spread your investments out over a wide range of stocks, bonds, and other types of investments, you will still see a good return on your investment with a lower chance of losing a large portion of your investment in the long term. The less tolerant to risk you are, the better it is to diversify to protect your assets from short fluctuations in the market.
Below are some of our best tips to maximizing your returns while lowering risk.
Avoid investing all or most of your investments in one stock or sector (i.e. energy, retail, etc).
This is the equivalent of putting all your eggs in the metaphorical basket. While you have the potential to make big financial gains by doing this, you also expose yourself to high risk and could possibly lose a significant portion of your investment very quickly. Instead, invest your money over a wide range of stocks from different sectors of the economy.
Utilize index funds to spread your investment over a broad range of industries.
This is a proven method toward long term success. Vanguard founder John Bogle created an entire business out of creating lost cost index funds that the average investor could buy shares of. These funds usually spread themselves out over many sectors of the economy and will shield you from large price fluctuations which are contained to small portions of the stock market.
Understand how different types of asset categories help your portfolio. Stocks bring long-term growth; bonds give you smaller, but steadier, low risk income; real estate will protect you from inflation and provide growth not tied to stocks and fluctuations in the market; international stocks help you take advantage of the growth in our increasingly globalized world; cash gives your portfolio security and is readily available in an emergency.
Make your investment regular.
Utilize Dollar Cost Averaging. My recommendation is to invest every other Wednesday. If Wednesday doesn’t work for you, pick another day. The key is to be consistent. Doing this over the long term, during times of good and bad economic performance, will ensure that you have positive long term growth.
Don’t forget about commissions.
Index funds and mutual funds typically charge an annual fee. Although investing in stocks, Exchange Traded Funds (ETFs), or other securities might not carry these yearly fees, purchasing them usually requires a transaction fee. Don’t forget to take this fee into account when buying or selling. If this fee is a fixed rate with your broker, it makes sense to make fewer, but larger, regular investments rather than smaller more frequent ones. Be sure to take advantage of investments with lower, fixed costs as well as ones which require regular transaction fees.
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