Diversifying your investments is the only way to make sure that a single investment decision doesn’t result in you losing your entire portfolio. Of course, this means more than buying stock from several different companies. A well-diversified portfolio should have equities from at least three of the following groups.
Stocks and Mutual Funds
Nearly every investor has stocks and/or mutual funds in their portfolio, but it is important to make sure you have the amount that is right for your current situation. The old rule was to subtract your age from 100 and keep no more than this percentage of stock holdings in your portfolio. For example, a sixty year old would want no more than 40% of his or her portfolio in stocks. With today’s longer lifespans, it is recommended that people use 120 instead of 100 when using this formula.
Bonds have traditionally been thought of as a hedge against stocks; that is, when stocks go down, bonds go up. If you’re thinking of expanding into this area, know that you’re not limited to corporate or federal government bonds. Municipal bonds have become much more popular in recent years as states and cities look to private investors to finance their debt. While they can be riskier than federal bonds, their returns are much higher.
ETFs or Exchange Traded Funds are a relatively new investment, but they are great choices for beginning investors or people who need a low maintenance investment. ETFs are essentially a collection of stocks that represents an entire segment of a market or exchange. Some ETFs, for example, own stock in every company that is related to energy. There are also ETFs that follow an entire stock index such as NASDAQ. When planning your portfolio, treat ETF investments as stocks, and make sure that you are not over-exposed.
There are a number of ways to keep real estate in your overall portfolio. Generally speaking, however, most investors choose to either invest in individual units or a Real Estate Investment Trust or REIT. Individual units, such as owning a rental home or commercial unit carry a lot of risk and are among some of the most time consuming investments an individual can make. They also have the potential for an excellent rate of return.
REITs are conglomerations of hundreds or even thousands of pieces of property. This can include residential, commercial, and industrial properties, as well as “raw” or empty land. Money is made through collecting rent and buying and selling property. These funds can be traded just like any bond or mutual fund, and depending on the fund they can pay dividends.
Gold is a commodity that has been in the news a lot lately as a popular investment, but there are thousands of commodities that are traded on a regular basis. Everything from agricultural products to precious metals are traded, but prices are extremely volatile. Because of this, it is generally recommended that individual investors keep no more than ten percent of their overall portfolio in commodities.
No matter where an investor is in his or her financial life, it is important to keep at least a small amount of cash on hand. For many people, a good goal is to have at least a year’s worth of expenses in cash. This allows an investor to ride out a bad market without being forced to sell at a loss. Cash does not necessarily mean sticking money under a mattress, however. Cash should be kept in either a standard bank account and/or within a CD or money market account. These funds are backed by the government, so your money is safe.