In the financial planning world, one of the most common pieces of investment advice is to diversify your interests. You may wonder, however, what diversification means and why it's important. Let's explore the idea of diversification as it applies to financial investments.
Different Assets
When you look at potential investments, you'll notice there are many possible ways to put your money to work. The most common tools are stocks and bonds, but there are ways to invest in real estate, annuities, retirement plans, and more.
One of the biggest mistakes that people make is investing too aggressively in a single class of assets. Worse, many people get narrowly focused on certain subsets. For example, someone might heavily invest in stock options for tech companies. That can be an amazing investment, but you shouldn't put all your money in one stock in case the market swings against you.
Risk Profile
A big reason to diversify is to ensure that your financial investments match your risk profile. Every investor has circumstances that determine how much risk they can take on and what their risk appetite might be. A couple with a newborn child, for example, is probably less inclined to take on major risks than a single person would be. Similarly, someone coming up on retirement will probably want to get more conservative as they prepare to take money out of their investments.
Mixture
Risk is not a monolith. One of the greatest risks can come from not taking risks because you may miss out on the biggest growth opportunities. Financial planning professionals encourage their clients to consider asset mixtures that allow them to address security needs and produce growth. You might, for example, invest in low-risk bonds to handle payments that are coming up in a few years while also buying stocks in newly listed and innovative companies. This strikes an appropriate balance between financial security and getting the biggest return possible on your investments.
Costs
It's also important to think about the potential costs associated with investing. What will you pay in terms of fees, for example? Also, you should prepare to deal with taxes and try to minimize what you'll pay to the government. With the right combination of low-fee and tax-preferred investing, you can keep your outlays as an investor to a minimum. Over years or decades, these savings can compound dramatically even in a low-growth model.
To learn more about financial planning, contact a professional for investment advice.
