Whether you employ the services of a financial advisor, or you’re a self-directed investor who manages personal finances, the more you know about investment basics, the better.
If you understand the principle of asset diversification, you’ll be better prepared to talk with your investment advisor about how you want your assets allocated. It’s important to stay involved in your investments and informed in investment basics.
Diversification is a primary consideration as your assets grow over time. The principle is recognized as sound advice by most investors who recognize the importance of spreading investment risk – of not “putting all of your eggs in one basket,” as the old adage warns. It applies to any investment portfolio.
If you don’t have the time to research a number of individual stocks across diverse economic sectors, consider investing in a mutual fund. A mutual fund is a “basket” of stocks designed to deliver stated results. For example, an income mutual fund invests in companies that generate income and dividends – cash that can be distributed to investors or automatically reinvested.
Assess your investment style. Even if you don’t know a thing about the ups and downs of stocks or bond markets, you probably understand just how much risk you can tolerate. Typically, when investing, the higher the potential return, the higher the risk. A highly risky “penny stock” may double your money in a day. It can also make your entire investment disappear. The risk-versus-reward equation is something to discuss with a knowledgeable advisor, or to weigh carefully if you’re the one calling the shots.
Even broadly diversified mutual funds come with an element of risk – some with great risk offering higher returns, or lower-risk mutual funds delivering lower but steadier returns.
What are a mutual fund’s objectives? As a self-directed investor, read any mutual fund prospectus carefully. Make sure you understand the investment purpose of any mutual fund before you invest.
Look at the fund’s earnings history – slow and steady growth or a history of major ups and downs?
Could you stomach a serious loss of your investment? Do you have the time horizon to recover from a market setback or does preservation of capital – keeping what you’ve got – take precedence in your investment strategy?
Automate the investment process. You can open an investment account through your bank and automate the savings process by moving money from a bank account into an IRA or some other investment vehicle on a regular schedule. This simplifies growing a diversified portfolio because you never “see” the money. Your portfolio grows with less self-discipline required when the money is moved automatically.
Further, you invest the same dollar amount with each automatic monthly transfer, which means you purchase more stock when the market drops and fewer shares when the market takes an upturn. Over the long term, this “dollar-cost-averaging” is employed by many self-directed investors who don’t want to spend hours a day evaluating performance.
You can also sign up for a 401(k) through your employer, if the company offers that benefit. Your contributions will be automatically deducted from your paycheck, and some employers will even match a certain percentage of your contributions.
Don’t over-diversify. If you own shares in 20 different mutual funds, each of those funds will charge a fee each year. Some mutual funds charge fees below 1%. Others charge higher fees, but all mutual fund investments come with fees attached – taken right off the top of a fund’s earnings.
Each fund may also charge an annual management fee, so if you own shares in 12 mutuals, that’s 12 management fee payouts you make. Choose several mutual funds, with a steady history of returns, and that fit your style. Your advisor will be able to recommend a collection of mutual funds that keep you diversified while lowering annual investment costs.
Diversify between growth and value investing. Value investing buys stocks or mutual funds that are currently low-cost and out of favor with investors, but expected to bounce back in value. Growth investing buys newer, lower-cost stocks and holds them until they grow in value.
Some investors prefer a growth strategy, others a value strategy. Many mutual funds are designed specifically for one type of investment or the other. Consider investing in a combination of growth and value investments. Once again, if you rely on a financial advisor, ask your advisor to allocate your portfolio to include a good mix of value and growth investments.
Some investors want to keep a close eye on their asset portfolios, while others rely on the good judgment of a financial advisor to follow your directions for investing based on everything from risk tolerance to your age, and when you’ll need those invested dollars to buy a home or pay some tuition bills.
A well-diversified portfolio takes into account your investment style and investment options. If you aren’t sure where to place your money for the long-term, talk to your investment advisor at your local bank.
Spread the risk to lower the chance that any one investment will undermine your portfolio and your objectives.
The information provided is presented for general informational purposes only and does not constitute tax, legal or business advice. Any views expressed in this article may not necessarily be those of Nevada State Bank, a division of ZB, N.A.
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