Smart Diversification: Optimizing Investment Portfolios for Better Results Lowers Risk and Increases Exposure to Investment Opportunities. Smart investors use smart diversification to place their circumstances at the center of their portfolio building for better investment results. With that approach, investors can consider fitting assets like cash, stocks, bonds, property, ETFs, or private equity into the process. That means each investor can consider how each asset type, business sector, or location fits their situation. Then, each investor can adjust each investment decision to fit their plan, goals, and timeframe.
What You Learn From: Smart Diversification: Optimizing Investment Portfolios for Better Results
This lesson explains smart diversification and how investors use it to lower risks and improve their investment results. Smart diversification helps investors build wealth faster with minimized risk. The smart diversification strategy can be applied by any investor to their investment portfolios. In addition, links at the end of the lesson access more related content.
FAQ About Smart Diversification: Optimizing Investment Portfolios for Better Results
The following FAQ and answers about smart diversification help investors learn about this investment strategy. Some answers overlap and provide context within those related topics. As a result, investors can see how each answer fits into the broader investment picture.
What does investment diversification mean?
Investment diversification means reducing the risk of an investment portfolio by owning different assets rather than a few similar ones.
Not putting all your eggs in one basket is an effective risk management strategy against disastrous loss. Should disaster strike one basket, the other baskets remain unharmed.
Smart diversification that puts each individual's unique circumstances at the center of their investment plan is the best individual investor strategy. It guides investors to meet their needs with various low-risk assets from different sectors and locations. That also enhances their exposure to a broader range of investment opportunities, amplifying their potential for success.
Why is investment diversification important?
Diversification is the philosophy of "don't put all your eggs in one basket." That allows investors to lower risk and increase money-making opportunities in unrelated investments.
Smart Diversification is a personalized investment plan centered on your unique circumstances. It's about making the best investment choices for you, not following the crowd. By diversifying, you protect capital while holding multiple opportunities. It just takes a few good picks from the best investments tailored to your needs.
Don't over-diversify because a few quality investments can spread the risk and generate good returns. Advisors recommending multiple dozen holdings waste resources to generate excess commissions instead of investment opportunities. Protect your capital; fire them!
What are the benefits of investment diversification?
Investors can reduce their investment risk and increase their opportunities by diversifying their investments across multiple asset classes.
Smart diversification is a flexible guideline rather than an absolute rule and fits each investor's unique circumstances. This approach lowers portfolio volatility, protects against market uncertainties, and provides more investment options without over-diversification that negatively impacts performance.
Effective investing is not about exposing oneself to everything but selecting excellent investments that match an investor's unique circumstances.
This approach avoids the over-diversification and lackluster outcomes from a one-size-fits-all approach used by too many financial service firms.
Can I use investment funds to diversify?
Building a portfolio with funds brings duplication and over-diversification risks that fund companies or advisors should disclose but most often do not.
Duplication happens when several investment funds own identical stocks. As a result, those duplicates don't diversify a portfolio but defeat the purpose of using funds to diversify.
Over-diversification frequently occurs when investors buy too many positions or funds. Significant index funds, in particular, diversify their owners across that index, so no additional diversification or funds are needed.
The big drawback of over-diversification is the portfolio's net underperformance! In contrast, successful investors use Smart Diversification to research and hold few rather than many diversified positions.
What are examples of investment diversification?
Investors diversify using different assets, like cash, stocks, bonds, property, ETFs, other funds, or private equity. Also, owning different business types from different sectors or locations is diversification.
Owning assets that store value, with others that are speculative, along with some reliable income producers, are also forms of diversification.
Diversification strategies range from one-size-fits-all, specific formulas, or the best fit for No-Worry-Investors, personalized Smart Diversification.
Smart diversification puts the circumstances of each investor at the center of the process to make each investment fit their life.
What is smart diversification for investors?
Smart Diversification guides personal investment choices to fit each investor's circumstances and minimizes risk with the best opportunities.
Making each investor the center of their financial plan impacts their money and income, location, and work/trade/professional decisions.
Smart Diversification can be learned and used by any individual investor to manage their wealth-building exposure to money-making opportunities at minimum risk. That approach tailors a portfolio to each investor rather than the generic one-size-fits-all approach. Results include improved risk management, more opportunity exposure, and the best personal fit!
Can portfolio diversification be a bad thing?
Yes, poorly done diversification can hurt performance without lowering risk. Over-diversification is the most common bad diversification. It happens when a portfolio invests in multiple duplicate holdings. For example, holding several large-cap funds all but guarantees duplicate holdings of multiple major companies. Those are bad investment decisions that add management costs and increased complexity while lowering returns. Another diversification miss is buying private or unlisted investments as diversification solutions. Rather than delivering diversification, those products bring higher risk and very high due-diligence costs.
The Essential Reasons For Smart Diversification: Optimizing Investment Portfolios for Better Results
Risk Management
Diversification helps spread investment risk across different asset classes, industries, and geographic regions. Investing in various assets offsets the impact of poor performance in one area with potential gains in others. That reduces portfolio volatility and helps protect against significant losses.
Minimizing Exposure to Specific Risks
Investing in a single asset or sector exposes investors to specific risks associated with that asset or sector. Diversification helps reduce risk by spreading investments across various assets with different risk profiles, making it less susceptible to declines in any single market segment.
Maximizing Potential Returns
Diversification enables investors to benefit from returns across various sources. While certain investments may perform poorly, others may excel, resulting in a more balanced and potentially higher overall return. Think of diversification as exposure that allows investors to seize opportunities in different markets and sectors.
Stability and Consistency
Having a diverse portfolio can provide stability and consistency over time. When some investments fluctuate, diversification softens the overall impact on the portfolio. This stability can give investors peace of mind and confidence in their long-term financial goals.
Adaptability to Changing Market Conditions
Different assets perform differently under various market conditions. Diversification allows investors to adapt to changing economic environments and market cycles. For example, some assets perform well during financial uncertainty, while others outperform during economic expansion.
Reducing the Impact of Behavioral Biases
Behavioral biases, like overconfidence or herd mentality, can cause investors to make irrational decisions. Diversification helps counteract these biases by offering a disciplined approach to portfolio management. It encourages investors to focus on long-term strategy instead of reacting impulsively to short-term market movements.
Overall, investment diversification is a crucial principle of effective portfolio management. It assists investors in balancing risk and return, improving portfolio stability, and increasing the potential for long-term investment success.
How Smart Investors Use Smart Diversification: Optimizing Investment Portfolios for Better Results
Smart investors use smart diversification as a superior investor tool to improve returns. They do that with increased exposure to more investment opportunities which lowers the risk of having investments too concentrated. Investors that learn to use smart diversification gain yet another superior investor skill.
Diversification & portfolio performance
We begin with a caution. Investors use diversification to reduce risk but they must be careful not to let bad diversification kill portfolio performance! Diversification means not having all your eggs in one basket. Having eggs in several different well chosen baskets lowers risks and increases exposure to other investment opportunities. And while it is desirable to be exposed to other opportunities for income and growth, we must be careful not to overdo it.
Overdone, diversification turns from a good thing into a portfolio performance killer. Too much diversification can make a portfolio underperform the market without providing greater risk reduction. Often, that happens when financial advisors make poor investment recommendations. Recommending a buy just to diversify is often a poor diversification suggestion. Sometimes a tempting sales commission can make advisors forget who they should be working for.
To be done well, a purchase made for diversification must also increase exposure to an investment opportunity. Don't buy just to diversify. It is a poor choice if there is no investment or growth upside. Buying just to diversify also harms portfolio performance.
Diversifying well requires knowing how to select investment opportunities from the diversification choices. Good choices have good market exposure while diversifying the portfolio to keep risks manageable. Investors should always make diversification decisions that are the best fit for their personal circumstances. That means every investment purchase must fit the individual needs and goals of each investor. Make the choices fit you, not the other way around. Every investment should meet your standard of being a good income or investment growth holding.
Always remember rule one
When portfolio building, we can always benefit by recalling the well-known rule one from Warren Buffett,
“Don’t lose money!”
Too many financial advisors and investors seek to reduce risk but misuse diversification by overlooking their personal circumstances. They can seek to cut risks and not lose money. But doing what works well for someone else, may not be a good fit for you. In particular, a mindless one-size-fits-all diversification strategy can be pushed by large investment firms. That approach to diversification can make sure portfolio performance is mediocre to poor!
Often, fund companies offer aggressively promoted balanced funds as the safe, diversified approach, for any and all. Such funds get sold as the answer for mature professionals at the top of their game and earning power. The same fund and approach are also offered to stay-at-home moms, housekeepers, aspiring athletes, recent graduates, and older people including retirees! One diversification approach for all! That approach gives no consideration of the very different circumstances of each person.
Amazingly, fund providers can offer the same answer to the diversification question of every investor. That one-size-fits all approach gives no consideration to the personal circumstances of each investor. Without consideration of how investors earn their living, where they live or their stage in life, all get offered the same fund as a diversification solution.
Fund diversification has high costs!
Large funds, promoted as an easy way to diversify, are indeed diversified. But diversified to the point that such funds or your portfolio managed in the same way, cannot possibly outperform the market! Such overdiversification kills portfolio performance.
Once investors pay all costs, the net performance of such an approach consistently under-performs the market! Many funds carry 70 or more positions. The large number of positions held ensures diversification at the cost of limited portfolio performance! That is expensive overdiversification and not smart diversification.
Smart diversification takes thought
More sage advice from Warren Buffett,
“Wide diversification is only required
when investors do not understand what they are doing.”
How, where and what we use to diversify needs us to have a smart process.
Learn and use smart diversification. Smart diversification helps smart investors become superior investors. You can outperform the market while being safely diversified. Smart diversification means considering the specific situation of each investor. Then tailoring diversification to fit that personal situation.
We want good investments and good performance without overexposure to any one sector or risk. We want good upside and control of our downside.
Smart diversification is a key to taking control of your financial future. Diversification is one tool that you can use to help control your financial future.
Diversification hedges, or partly insures, that you have more control of financial and economic risks in your life. Done well, it minimizes the impact of bad news or the downturn of one investment on your economic life. It attempts to position your investments, so a setback in one investment does not financially devastate you.
Smart diversification process
Superior investors use smart diversification as a process to develop the best strategy for them. Much of it is an exercise in personal awareness. With that awareness in place, you can confidently diversify well.
Smart diversification centers investment decisions on you
Building financial security and retirement independence is a very personal process. Just as your life is unique and different, for the best result, you must also craft the financial plan that uniquely fits you.
Managing the diversified portfolio
Smart investors use smart diversification to lower risk while outperforming the stock market. They do that with careful diversification selections that mean smart investors do not give up any small investor advantages. Still, the following approach keeps risk under control while achieving a record of outperforming markets. Consider the points below while making your diversification decisions.
Look at your big picture
Begin the smart diversification process by looking at your personal big picture. First, know where you are. Only then can you plot the direction to take you to your goals. As always, consider your own financial situation and risks.
Take a personal big picture. Take a holistic view of your financial and economic life. For yourself, answer the basic question, “Financially, where am I?” You also have to know any other financial entanglements or obligations in your life. Where are you in you relationships. Be it your brother, sister, parent, child, friend, neighbor, and even your partner may have very different attitudes and points of view.
While your point of view is the one that matters to your plan, you can not ignore any other obligations or responsibilities. This important first step is about you and just about taking your point of view. Understand where your money comes from. Think about what could put that at risk.
Diversification in investing
To discuss the diversification of your investments, you need to take a broader view of your financial circumstances. However, to do that well, you need to consider the parts of the economy and all the financial risks you have in your life.
Someone living and working for the company in an industry-built community has a very different financial exposure profile than a civil servant employed in a government town. A teacher with portable job skills and opportunities has different financial risks than a mortgage broker living in the same rural agriculture-based community.
Their risk exposure differs so their diversification and financial plans also must differ. To develop your own plan, begin by considering your own big financial and economic picture. Identify your exposure to both risks and opportunities.
Personal big picture considerations
Assets and liabilities
List your assets (your stuff, like house, car, bank account, savings, investment account, etc.) and liabilities (what you owe, debts including credit card, loans, mortgage(s), and any other obligations you have). That tells you where you are beginning, in a financial sense.
Skills and Education
What employable skills and value do you offer? What makes you economically valuable? How transferable are you? This gives you the opportunity to consider how your package of skill, ability, knowledge, and education could improve your employment or income.
Income
Investors must make regular contributions to their future. Realistically review your income and what you can do to improve it. How much more can you give to your future?
Employment
How secure is your employment? Is there anything you can or want to do about improving it?
Employer
Consider how secure your employer is in both the industry and in the market. Should you be looking for a better situation?
Industry
How secure is your industry? What competitive threats are there? What economic forces pose threats? Should you continue working in that industry?
Community
What is the economic base of your community? What economic forces could hurt that economic base? Is this where you want to live your life?
Family and Personal Relations
Ignore the relationship-related financial risks at your future financial peril! Be realistic, be honest. If it needs fixing or changing, get to work on doing something about it.
Identify and address any issues
Either by using an excellent financial advisor or running your own portfolio, you can benefit by putting yourself through this process. An honest and complete big picture review always uncovers problems and challenges. Acknowledge the issues yourself.
Make a list of issues and address them one by one. Come up with a plan and get to work on making it happen. The effort will pay off with a better future. Make it great!
If you design cars, sell dresses, program computers, haul gravel, or do payroll for a sawmill, you know the organization must prosper to keep your paycheck coming. Think about the risks of the business and your industry. Know the risk exposure of your income. Know what parts of the economy affect you most.
Identify community economic risks
When considering your community, learn what economic activity drives the place. Where does the money come from?
Every community has an economic base and risks associated with that base. Identifying that base and risks gives you useful knowledge. You can use that insight and the smart diversification process to lower your risk.
A fishing community or other resource town is very different from a transportation hub or a capital city. Just as a manufacturing center differs from a technology-based region or a local economy dependent on an armed forces base differs from a seasonal holiday resort community.
Each community and the people living there have different financial risks. Identify the economic base of your community. Knowing that improves your awareness and your ability to make smart diversification choices.
Living in an oil town, working for the oil company, with your portfolio holding shares in the same company along with mutual funds that have 30% exposure to the oil patch and energy, is not diversified! That is high risk! To address that and every other situation, we continue in the next post in this series, the smart diversification process. Smart diversification can help every investor meet the need for personal diversification.
Smart diversification personal picture
To recap, when it comes to diversifying their portfolios, smart investors take a tailored approach that fits their individual circumstances. This means taking into account factors such as their assets and liabilities, skills and education, income, employment situation, and personal relationships when making investment decisions. By doing so, they are able to mitigate risk and maximize opportunities for growth.
To wrap up a smart diversification process for any investor means taking the time to carefully consider those big picture personal circumstances. It also means addressing and resolving any issues that arise. Your financial future and wealth depend on it as does your happiness.
Takeaway Points For: Smart Diversification: Optimizing Investment Portfolios for Better Results
The lesson covered how to use smart diversification. The benefits to investors include lower risks, increased investment exposure and meeting the unique needs, goals, and timeframes for each investor.
Other Lessons Related To: Smart Diversification: Optimizing Investment Portfolios for Better Results
Investing academics hold court
Yes to dips but no to averaging down
Time to invest or time for an advisor?
Comments and questions welcome
Email me at [email protected].
Subscribe free and get White Top Investor lessons in your inbox!
Make money work for you by knowing how investors think, feel and act. Learn here The Investor Mind.
White Top Investor lessons, website layout, and organization: click here.
Make money work for you
Use White Top Investor lessons to learn investing. By doing that you can grow into a knowledgeable, comfortable, and confident investor. To learn how you can learn investing one small step at a time at your own pace. Do that and become the master of your financial security and independence. White Top Investor never sells or shares our email list. Learn more.
Making Money With Investing Success, lesson links:
Key investing success lessons Lesson 1
Top 4 ways to find money to invest Lesson 2
Time to invest or time for an advisor Lesson 3
Low costs double returns as ETFs beat mutual funds Lesson 4
4 Successful investor traits Lesson 5
Small investors have advantages Lesson 6
Avoid 6 investing sins Lesson 7
Investment impatience destroys wealth Lesson 8
3 Yeses or no investment Lesson 9
Investing can be fun, interesting and slow Lesson 10
Warren Buffett explains gold Lesson 11
Next suggested course:
Investments That Make Money Work
Share: Smart Diversification: Optimizing Investment Portfolios for Better Results
Buttons below you share this lesson with family and friends!
Image courtesy FreeDogitalPhoto.net
Lesson code: 370.01.
Copyright © 2011-24 Bryan Kelly
WhiteTopInvestor.com
