When you decide to invest in mutual funds or anything else, diversification is the best way to protect your investment. Mutual funds are an easy, inexpensive way to diversify your investments. That is one reason why mutual funds are so popular. However, most investors don’t diversify correctly. They own too many mutual funds, they hold too much in cash, or they do not invest enough money.
That is not smart investing. Once you understand how to diversify correctly, you will have a critical advantage over other investors. Since the financial markets are as predictable as the weather, you need a strategy to help prevent you from losing money. I can’t predict exactly when it will rain, but I can give you an umbrella to help protect your investments. How am I going to do it?
I’m going to show you how to diversify effectively. The key to diversification is spreading out your money over different types of investments. Your investment portfolio has endless possibilities. There are many different ways to diversify, and some of them will work for you. There is no “one size fits all” strategy to diversification.
Here are ten different ways to protect your investments:
1. By investment type. Most investors are familiar with this method, which can include stocks, bonds, mutual funds, currency, convertible securities, and real estate. The values and earnings vary greatly for different types of investments. Make sure you choose the type of investment that is right for you.
2. By country. The global economy is becoming more connected, with more companies and countries working together to earn profits. Investing globally in different countries can prevent you from losing money if one country’s economy slow down.
When the United States goes into a recession, investments in foreign countries may perform better. Foreign currency is another way to diversify by country. Some foreign currencies hold their value better over the long-term, which can add security to your investments. This can also help you fight inflation.
3. By industry. Each industry has different market cycles and different profits. An energy company may earn different profits than a retail company or manufacturer, and investing in different industries can give you an average of their returns.
Index funds are a great way to invest in many different industries with low costs. Many investors follow the Dow Jones index, which is itself an average of major industries. Sector funds can also help you mix up the industries in your portfolio.
4. Market capitalization. This term refers to the size of a company. Smaller companies have different market cycles than larger companies, so they earn different profits.
Investing across different sized companies can minimize risk in a difficult market. Smaller companies also have fewer investors, so investors may find underpriced opportunities more often by investing in small companies.
5. Investment company. There are many investment companies available out there, and even more financial brokers. Every company is different. The company that manages your investment has a significant impact on your risks and returns. Make sure you feel comfortable investing your money there.
Mutual funds, stocks, and bonds are not guaranteed like a bank deposit, so it will be difficult to recover your investment if a company goes bankrupt. Investing with different companies can help protect against this.
6. Investment style. Equity funds usually focus on one of two investment strategies: growth or value. These strategies usually take turns outperforming each other, which can be a roller coaster ride if you focus on one investment style. By investing in both, you can get the average performance of both styles with moderate risk.
7. Market development. Financial markets like the stock exchanges in New York, London, and Tokyo have been around for over 60 years. Investments are generally less risky in developed countries with productive economies and stable governments. Emerging markets usually do not have a well-developed economic structure. Investments in these countries can have explosive growth.
8. Rate of return. It is impossible to predict which investments will perform best in the future, so chasing the hottest new funds will almost always lead to below average returns.
Keep an eye out for funds have fallen out of favor recently but still have great management, low expenses, and solid long-term performance. These “sleeper” funds may keep your returns climbing.
9. Holding period. Stock traders will hold different stocks for different periods of time. This is a strategy that investors can also take advantage of.
Set different target dates for some of your investments, and write it on your financial statement. Once your investment reaches the target date, it is time to consider selling it for a better opportunity. This can help you take advantage of market cycles, and you can always come back to a good investment later.
10. Cash. Sometimes investors forget that keeping your investments in cash is a viable option. Investors usually want to have as much invested as possible, but cash can sometimes be a good choice.
Avoid using the “all or nothing” approach to cash when the market becomes chaotic. Investors who panic and move 100% of their investments into cash usually do it at the wrong time and miss any market recovery.