As a beginner starting to invest, the first thing you need to do is learn how to diversify your portfolio. Diversifying your portfolio is essential for protecting yourself against a market crash or recession.
Fortunately, diversifying your investments is easier than you may think. Really, it just means that you shouldn’t buy too much of the same thing.
If you are just starting to invest your money, look for a variety of options to put your money into. Even if you are an experienced investor, reassess your portfolio occasionally to make sure you are diversified.
What is Portfolio Diversification?
Diversifying your investment portfolio means that you hold multiple types and varieties of investments. It spreads your risk across multiple companies and financial vehicles so that you don’t lose everything if that investment crashes.
Think about it this way. You could buy shares of stock from one individual company to make up 100% of your invested money. When that company does well, you will benefit and earn greater returns. At the same time, if that company has some tough times or goes bankrupt, you could lose 100% of your investment.
By diversifying your portfolio across multiple stocks, you reduce the impact if one company does poorly. For example, owning shares of 10 different companies will reduce the impact by 10 times. The problem with just selecting a few stocks is that you still have risk from stock market crashes.
Besides just owning stocks from multiple companies, diversification works best by investing in different sectors, domestic and foreign opportunities, and financial instruments. Choose opportunities that have different levels of risk and different rates of return.
By diversifying, some of your portfolio may perform well when other investments are doing poorly. This protects you as best as possible from stock market crashes, individual companies and sectors suffering hard times, and unforeseen disasters.
Investment Types for Diversification
Now that you are in the mindset of investing in a wide range of holdings, it’s time to start to putting your money to work.
We put together guides on how to start investing as a beginner with only $1,000. If you have a little more money, here are some ideas on how to invest $10k like a millionaire.
To fully diversify your portfolio, aim to own as many of these different types of investments as possible. Choosing the right percentages to own is also important, so we’ll get to that in a minute.
Here are ideas on diversifying your investment portfolio as a beginner.
1. Domestic Stocks
Domestics stocks allow you to own pieces of companies that are based in the United States. They make up the three U.S. stock markets, which are the S&P 500, Dow Jones Industrial Average, and Nasdaq Composite.
As a shareholder, you can hold onto your shares and hopefully sell them when they appreciate over time. They can also pay out dividends periodically, which is distribution of company profits to the shareholders. Both capital gains and dividends play into the overall returns that you can see from investing in stocks.
2. Foreign Stocks
Foreign stocks are similar to domestic stocks in the sense that they allow you to own shares of different companies. The difference is that they are companies based outside of the United States and are generally not as affected by the U.S. economy.
Foreign stocks help to diversify your risk away from the U.S. stock markets and changes that affect U.S. businesses, such as taxes. Other countries certainly face their own business challenges and the United States economy does play a role in the world economy. That said, foreign stocks are a little more removed from the U.S. economy and help to diversify your stock’s performance.
3. Bonds
Bonds are loans that are made to companies and governments that have to be repaid at a certain rate. They usually have relatively low interest rates but are much more stable when compared to stocks. They are less volatile than stocks and their value often goes up when stocks go down.
Bonds can also be domestic or international and have varying term lengths that can impact the interest rates. They generally are viewed as a way to stabilize your portfolio and hedge against stock market crashes.
They are a good option to load up on if you think there may be a recession coming or to ensure you don’t lose value in the short term. Increasing your percentage of bonds is usually a good idea if you are nearing retirement age. It could also be a good idea if you will need the money for a purchase in the near future.
Besides bonds that can be purchased through the stock exchange, you could purchase individual savings bonds such as Series I or EE. They provide a fixed interest rate for up to 30 years and are a stable and conservative investment.
4. Funds
There are a variety of different types of funds available that automatically help to diversify your investment. This can include exchange-traded funds (ETFs) and mutual funds.
Funds are composed of different stocks, bonds, and assets that are traded and managed as a bundle. For example, an S&P 500 Index Fund holds shares of the top 500 companies in the S&P stock market. By buying one index fund, you will spread your holding across 500 different companies.
Types of funds include:
- Exchange-Traded Funds (ETFs): Index funds and ETFs track the performance of whatever market index they represent, such as the S&P 500. They usually are composed of every stock in the index and perform the same as the overall index. ETFs are passively managed, can be traded on the stock market, and have a low expense ratio.
- Mutual Funds: Mutual funds also are composed of a range of assets but are actively managed. The fund manager makes constant adjustments to try to beat the returns of an index fund. Since it is actively managed, mutual funds have higher expense ratios and I normally would not recommend using these.
- Sector Funds: These are funds that focus on one specific sector of the economy, such as energy or healthcare. Different sectors perform differently during the same period of time, so you can improve your overall returns by investing in different sectors.
- Commodity Funds: These funds are composed of commodity assets like oil, gas, and minerals. Investing in commodities can help to protect you against inflation while making it easy to get into commodities.
Stocks, bonds, and funds can all be bought and sold on trading platforms like M1 Finance.
5. Real Estate
Real estate is a great way to diversify your portfolio because the housing market often moves separately from the stock market. Even if the stock market crashes, real estate can continue to appreciate and gain value with time. Rental income and dividend payments can add to your income.
If you can save up enough money for a down payment, you could purchase an investment property to rent out. This is not true passive income because you will need to manage your tenants and perform repairs.
An easier option is to invest in a real estate investment trust (REIT). REITs are funds that invest in multiple properties for you and pay our dividends as they profit. They can be traded on the stock market and are easy to get into different types of commercial and residential real estate.
Very similar to REITs are crowdfunded real estate platforms like Fundrise and DiversyFund. They allow you to buy shares of real estate properties and benefit from both dividend payouts and capital appreciation over time.
6. Gold and Precious Metals
Gold is another good investment since its value has historically gone up over the long term and averages around 10% per year. Like any investment, it can have downturn periods, but will go up in value over the long run.
There are funds and companies that track the performance of gold and can be traded on the stock market. Mining companies are one example of benefiting from the cost of gold going up.
Another way is to simply buy gold bars and hold them. You can physically buy them and store the gold bars in your own safe at home. Or, use a company like Vaulted to buy the gold and store it for you so you don’t have to worry about its security.
7. Peer-to-Peer Lending
Peer-to-peer (P2P) lending is an alternative form of investing that lends money to individuals or small businesses. In return, you will earn a set interest rate until they pay you back entirely.
Be aware that P2P lending can be riskier than other investments because you are lending money to individual people. Depending on their credit, they may default on the loan and not pay back at all.
One platform that helps to reduce that risk is MyConstant because it uses crypto collateral to reduce the risk and pay out over 7% annually.
8. Alternative Investments
Besides the more traditional investments, you an branch out to into alternative investments that can have solid returns. These can include any type of appreciating asset that increases in value over time. Just buy them at a lower price and then sell those assets at a higher price. Investments ideas include art, fine wine, whiskey, and collectibles like sports cars, baseball cards, and antiques.
An emerging form of investment is cryptocurrency, best known for Bitcoin. There are numerous cryptocurrencies available to purchase or trade and they are digital currencies that can be used to buy things online. While they can be attractive investments, they are not regulated by a government and are a relatively new form of alternative investment that could be risky.
How Do You Diversify a Portfolio?
The first step to diversifying your investment portfolio is to take stock of what you currently have invested. Figure out what types of assets you own and what rates of return they are earning. Identify your holes and areas where you are missing certain types of assets.
Next, make a list of the asset types you need to invest in to better diversify. Make a plan to buy those assets as you are able to invest more money. If you have a large amount of money invested in one asset type, it may make sense to sell part of it and purchase something else to rebalance your portfolio.
As a beginner investor, you’ll want to start with a few type of investments that include index funds, crowdfunded real estate, and a selection of stocks and bonds. This will provide a good amount of diversification in your portfolio to start. Over time, you can expand your investments to include other types.
Make sure that you are balancing your risk level across your portfolio and that it meets your financial goals.
Portfolio Allocation Percentages
Your own portfolio allocation will depend on your specific financial goals and where you are currently in life. Your portfolio will also change over time as you hit different milestones in life. An investment portfolio of a 25 year old will look much different than a 65 year old.
A rule of thumb in investing is to subtract your age from 100 to determine how much stocks you should own. A 30 year old would invest 70% in stocks while a 60 year old would invest 40% in stocks using this rule. Some people think this is too conservative and prefer to use 110 or 120 as the starting point.
As you build your own personal portfolio, look to diversify outside of just stocks and bonds to build long term wealth. An example portfolio allocation could be:
- S&P 500 Index Fund: 40% from M1 Finance
- Growth & Dividend Stocks: 20% from M1 Finance
- Bonds: 20% from M1 Finance
- Real Estate: 10% from Fundrise
- Peer-to-Peer Lending: 5% from MyConstant
- Gold: 5% from Vaulted
As you determine the percentages for your assets, take into account the expected returns and the level of risk for each one. Adjust the percentages for each type of investment until you reach your overall goal for returns and risk level.
Rebalancing Your Portfolio
Over time, the asset allocation of your portfolio will drift as individual values change. Your holdings that do well will increase in value and take up a larger percentage of your investments than the ones doing poorly.
This is fine for the short term, but will impact your target goals over time if you don’t rebalance your portfolio. Rebalancing your portfolio allows you to maintain your target asset allocation so that you can maintain your risk level.
For example, you may be comfortable with having 20% of your investment in bonds. If that drifts to 15% in bonds, you now have less protection against a stock market crash. On the flip side, if it drifts to 25%, you now have more bonds that reduces your overall returns.
There are two ways you can rebalance your portfolio.
The first is when you use a trading platform and you ask to have all of your holding rebalanced to meet your set allocation percentages. I use M1 Finance for all of my stocks, bonds, and funds and it allows you to create a “pie” with certain percentages of each one. Just by clicking one button, I’m able to automatically rebalance my pie back to my target allocations.
As you expand your investments outside of just one trading platform, you’ll need to track your investments. To do this, you can use a spreadsheet to track the value of all your investments and calculate the percentage of your overall investment. I like to use Personal Capital to track my investments automatically for me and see everything in one simple dashboard.
The second way to rebalance your portfolio is to buy additional investments of a specific type. Let’s say you want 10% invested in Fundrise as real estate. Over time, you may realize that your real estate value has dropped to 8% of your total investments. To rebalance your portfolio, simply focus your next investment on Fundrise instead of buying more stocks or bonds.
Summary
Diversifying your investment portfolio is the best way to improve your overall returns and insulate you from economic downturns. A properly diversified portfolio reduces the risk and impact of one investment performing poorly.
Choose different allocations across a variety of assets, including:
- Index funds or low-cost ETFs
- A mix of domestic and foreign stocks
- Short, medium, and long term bonds
- Real estate, including REITs and rental properties
- Gold and silver
- Peer-to-peer lending
- Alternative investments like art, fine wine, and crypto
Determine your goals for target returns, how much risk you are willing to take, and when you will need to access your money. Using that information, adjust your portfolio percentages to meet those goals.
Bottom line: Don’t put too much money into a single investment or have too much trust in one company. Be optimistic in their performance, but plan for the worst by diversifying to minimize your risk.
