In contrast, short-term bonds with maturities of a few years or less are considered to have the least amount of interest rate risk. There are a number of asset classes that do not fit neatly into the stock or bond categories. These include real estate, commodities and cryptocurrencies.
Creating a diversified portfolio with mutual funds is a simple process. Indeed, an investor can create a well diversified portfolio with a single target date retirement fund. One can also create remarkable diversity with just three index funds in what is known as the 3-fund portfolio.
However one goes about diversifying a portfolio, it is an important risk management strategy. By not putting all of your eggs in one basket, you reduce the volatility of the portfolio while not sacrificing significant market returns.
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Heard the adage about not putting your all your eggs into one basket? The same concept applies to managing your investments. Diversification essentially means allocating your investment dollars strategically among different assets and asset categories to help manage risk.
Here are three ways to do it. Diversification is mitigating the risk to you about such scenarios by choosing different investments and types of investments. A well-diversified portfolio combines different types of investments, called asset classes, which carry different levels of risk. The three main asset classes are stocks, bonds, and cash alternatives. Some investors also add other investments, such as real estate and commodities, like gold and coal, to the list.
Stocks generally carry the most risk of the three main asset classes, but they also offer the greatest potential for growth. Bonds are less volatile, but their returns are more modest, and cash alternatives are generally considered to carry the least risk but with the lowest returns. Each asset class tends to perform differently under similar market conditions.
Asset allocation, or splitting your assets among categories, helps to balance your portfolio. Investors typically choose a percentage they want to invest in each asset class based on their risk tolerance, years until retirement, and other factors. A person just a few years from retirement might shift money out of stocks and into bonds or cash for a more conservative allocation.
For example, when it comes to stocks, the possibilities for diversification are vast. You can diversify by the size of the companies large-, medium-, or small-cap stocks , by geography domestic or international , and by industry and sector, for example. These funds generally hold shares in many different companies. There are also funds that shift their asset allocation away from equities as it approaches a certain target date. Our mission is to provide readers with accurate and unbiased information, and we have editorial standards in place to ensure that happens.
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The information on this site does not modify any insurance policy terms in any way. Diversification means owning a variety of assets that perform differently over time, but not too much of any one investment or type. In terms of stock, a diversified portfolio would contain or more different stocks across many industries. But a diversified portfolio could also contain other assets — bonds, funds, real estate, CDs and even savings accounts.
Each type of asset performs differently as an economy grows and shrinks, and each offers varying potential for gain and loss:. As some of these assets are rising rapidly, others will remain steady or fall. Over time, the frontrunners may turn into laggards, or vice versa. Diversification has several benefits for you as an investor, but one of the largest is that it can actually improve your potential returns and stabilize your results.
By owning multiple assets that perform differently, you reduce the overall risk of your portfolio, so that no single investment can hurt you.
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