Most of us design our investment portfolios to meet a specific set of goals or objectives. However, our portfolios face many risks to their ability to assist us in meeting these goals and objectives. As investors we face many risks to our portfolios.
The best means to minimize risk to our portfolio is to establish a discipline methodology to constructing an appropriately diversified portfolio. Portfolio diversification is the risk management practice that seeks to minimize risks while maximizing returns. By diversifying holdings an investor attempts to spread these risks across various investments to reduce the probability of a large loss to the portfolio. For example a portfolio consisting of a mix stocks and bonds is more diversified than a portfolio of all stocks. Thereby minimizing the impact of significant drop in the stock market.
Generally in a diversified portfolio not all assets will move in the same direction at the same time. However, in a concentrated portfolio the assets all move together both up and down. In an up market an investor may realize extra ordinary gains. In a down market, especially one of significant duration the investor will suffer substantial loss of their capital.
In constructing a diversified portfolio the investor will want to look at the variety of asset classes. These would likely include but not be limited to stocks, bonds, real estate and commodities. Among these asset classes an investor will likely want to refine their search further. Within stocks, an investor may consider not just US stocks but stocks of companies from countries of developed or emerging economies. With bonds an investor might look at US government bonds, foreign government bonds or domestic and foreign corporate bonds. When reviewing commodities an investor may consider precious metals such as gold or silver or agricultural products. By striking an appropriate balance among asset classes an investor seeks to meet their goals while reducing the impact of a single asset class losing value.
While a diversified portfolio may not realize the exceptional short-term gains that a concentrated one might achieve, over the long term a diversified portfolio should smooth the significant ups and downs investors are subject to. This smoothing action should result in greater long-term returns from the portfolio ensuring the investor has a greater opportunity of reaching their goals and objectives.
The content contained herein represents the author's opinion and should not be regarded as investment advice, which is provided only to Agnew Capital Management LLC clients upon completion of a written plan.