Young Investor’s Guide to Building a Financial Future - Get Diversified

Part 4

 

 

In the short term, stock market swings can test even the strongest-willed investor. But over the long term, the market has historically shown a remarkable ability to smooth out performance and head in an upward direction. Holding a diversified basket of many different types of investments helps your portfolio weather short-terms bumps in the market and benefit from the market’s growth over time.

 

What is diversification? In a general sense, it’s about spreading your risks around. In investing, that means it’s more than just ensuring you have many holdings. It’s also about having many different kinds of holdings.

 

While this may make intuitive sense, many investors come to us believing they are well-diversified when they are not. They may own a large number of stocks or stock funds across numerous accounts. But upon closer analysis, we find most of their holdings are concentrated in large-company U.S. stocks, or similarly narrow market exposure. Diversification works because different types of investments react differently as market conditions change. When one investment falls on hard times, others might be performing well, and can buoy the overall performance of a portfolio. If all of your holdings are too similar in nature, diversification is unable to work its wonders over time.

 

So how do you get diversified without over-complicating your life? Seek an advisor who takes time to learn about your specific risk profile and recommends a broadly diversified basket of stocks that tracks the overall market.  These days, your basic, well-diversified fund can be relatively inexpensive. Your advisor can help you build a well-diversified portfolio with just a handful of these sorts of low-cost holdings.

 

As your wealth grows, you may decide to add an exposure to systemic market factors that have been shown to enhance portfolios over time. For example, in “How Targeting Size, Value, and Profitability Can Improve Retirement Outcomes”  Mathieu Pellerin, PhD, Senior Researcher and Vice President of Dimensional Fund Advisors notes that, “value” companies have “low relative prices (stock price divided by an accounting metric such as book value).” Over time and in aggregate, such companies have delivered a built-in premium return compared to growth companies. A thoughtfully constructed value fund or ETF  - held over the long run - could increase the odds of experiencing higher returns over time, if you’re also willing to accept a likely wilder ride along the way.

 

In short:

 

Investing broadly across assets of various sector, size and geographies can help you build a resilient portfolio that can better weather the ups and down of the market over time.

 

Interested in learning more about how to take the first steps toward meeting your personal financial goals? Reach out to set up a time, and let’s talk.