Define: Diversification and Asset Allocation
In fashion, black is a great staple – it goes with everything, is slimming and wears dirt very well. But it’s probably one of many colors you have in your closet. Similarly, your portfolio is full of investments in the separate classes of assets and securities (stock, bonds, cash), some of which may then be spread across different companies in an attempt to lower overall investment risk. Your portfolio should be as varied as a closet which can take you from the gym in the morning, through the daily grind and out that night.
The diversity of your portfolio should show a risk to return relationship appropriate to your financial goals (yours, not the planners). If you can afford to be more adventurous, your portfolio may include aggressive growth stocks, stock in smaller companies, high yield bonds and maybe some real estate or sovereign wealth funds. A more conservative portfolio might hold large cap value stocks, broad based market index funds, and some bonds.
If you’re trying to figure out the right portfolio diversity for you, consider:
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Is my portfolio diversified among stock, bonds, and stable value investments?
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Are my stock investments diversified by investment style, size, and geographic location?
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Are my bond investments diversified by the quality – and interest rate- of the bond?
Like that special l.b.d. in your closet, your portfolio needs a little attention from time to time, and the right accessories. You’ll need to review, revise and rebalance. For example, during booms many stock funds rise in value, and you may end up with a disproportionate stock allotment to your goal. At this point, revise and rebalance your portfolio to your goals. Below is an illustration from DWS Scudder of one portfolio revised after such a boom.
Finally, again like the perfect wardrobe, a diversified portfolio provides for eventualities and is always age appropriate. Staying diversified among different asset classes and within different asset classes can help you keep calm during times of market upheaval, and even during the R-word.