Diversification is the practice of spreading your investments around so that your exposure to any one type of asset is limited. This practice is designed to help reduce the volatility of your portfolio over time. If well designed, an international portfolio gives the investor exposure to emerging and developed markets and provides diversification.
The 4 primary components of a diversified portfolio
Stocks represent ownership shares of companies, and domestic stocks in your own home country are the foundation of almost every portfolio recommendation you’ll find. Stocks are generally more volatile than other types of assets, your investment in a stock could be worth less if and when you decide to sell it.
Unlike stocks, bonds don’t give you ownership rights. They represent a loan from the buyer (you) to the issuer of the bond. Investors who are more focused on safety than growth often favour high-quality bonds, while reducing their exposure to stocks. These investors may have to accept lower long-term returns, as many bonds—especially high-quality issues—generally don’t offer returns as high as stocks over the long term. However, note that some fixed income investments, like high-yield bonds and certain international bonds, can offer much higher yields, albeit with more risk.
International and global stock funds can be an important part of a diversified portfolio. Like all mutual funds, international and global stock funds can potentially invest in a large number of securities, giving you a cost-effective way to own shares in many different companies.
Short-term investments, also known as marketable securities or temporary investments, are those which can easily be converted to cash, typically within 5 years. Some common short-term investments and strategies used by corporations and individual investors include: Certificates of deposit (CDs), Money market accounts, Bond funds, Municipal bonds, Roth IRAs.
Determine Asset Allocation
The first step in building a global portfolio is assessing your risk tolerance and determining the right asset allocation. Depending on your risk tolerance, you can adjust their exposure to certain classes of equities and bonds that are more or less risky than others.
Investors comfortable with taking on a lot of risk may prefer to build a portfolio that holds mostly equities and few bonds, while those that are more risk-averse may want to look at a greater percentage dedicated to bonds. In terms of asset classes, risky investors may want to consider small-cap stocks, emerging markets, and corporate bonds, while those that are risk-averse may want large-cap stocks, developed markets, and government bonds.
Why you need to diversify your portfolio
Diversifying reduces the uncertainty of investing
There is a level of uncertainty in every financial market. If you put all your money in stocks, you risk losing everything if the stock market crashes. The same applies to the real estate market, commodities markets, currencies, and any other investment. However, all markets hardly crash at the same time, in the same manner.
The same applies to investments in the same asset class. For instance, two stocks of different companies in different sectors fluctuate differently. By diversifying, which is just putting your money in various investments across different sectors, the probability of losing a significant amount of money or your entire investment is very low.
Get your business account within minutes and manage your financials with ease.