October 7, 2024
6 Essential Tips For Diversifying Your Portfolio

Gregory Clifford is Founder and CEO of The Clifford Group.

Diversification refers to investments spread across sectors and asset classes. It allows investors to mitigate the impact of poor performance from any single investment. This approach unlocks potential returns by capitalizing on the performance cycles of your investments, leading to a more stable and resilient portfolio over time.

1. Understand asset allocation in terms of market capitalization.

Large-capitalization (cap for short) equities are financially stable and less volatile than smaller equities. They often provide steady growth with consistent dividends. Small-cap equities with a market capitalization of less than $2 billion are known for their high growth potential but come with increased risk. Mid-cap equities can balance the stability of large caps with the high growth potential of small caps.

The real question is how much of each market cap you should include. The answer depends on many factors, including investment objectives and time horizon.

Investors with a higher risk appetite may allocate a larger portion of their portfolio to mid- and small-cap equities to capture high potential returns. Risk-averse investors often prefer a higher allocation to large-cap stocks for their reliability.

Your financial objectives will also influence your market cap allocation. For example, if you aim for income and preservation of capital, large-cap stocks may be more suitable. If you seek aggressive growth, a higher allocation to mid- and small-cap equities could be a beneficial solution.

Finally, the time frame of your investment is critical in deciding a proper market cap allocation. Longer time horizons allow investors to ride out price fluctuations and capitalize on the appreciation potential of mid and small-cap equities.

2. Avoid sector concentration.

Many investors don’t realize that buying individual stocks can sometimes mean holding very similar or even directly competitive businesses. For example, owning positions in both Lockheed Martin and Boeing can lead to sector concentration in aerospace and defense. If this sector faces adverse conditions, your portfolio could suffer.

By spreading investments across sectors such as technology, healthcare, financials and consumer goods, investors cushion their portfolios against sector-specific issues. It also enables their portfolio to withstand market corrections.

3. Monitor interest rates to maximize cash positions.

The Federal Reserve raised interest rates significantly in the past two years, making cash an important asset class in your portfolio.

Interest rates can change quickly, sometimes overnight. Higher interest rates mean that cash can provide both liquidity and a respectable yield if managed properly. It is important to stay informed. Institutional tools are available, but for individual investors, free resources like Morningstar can be particularly useful for tracking interest rates.

Review your cash positions and the interest rates they earn. Sometimes, the path of least resistance is to leave your cash where it is. However, this approach can lead to significantly lower returns. I have observed cases where failing to manage cash positions results in 50% less income than would be possible with a more proactive strategy.

4. Use a ‘barbelling’ approach to fixed income.

Fixed-income investments, bonds, are debt securities that pay investors regular interest and return the principal investment at maturity. Given that the Federal Reserve has raised rates significantly, short-term bonds have become more attractive. Allocating a portion of your fixed-income investments to bonds maturing within the next two years can minimize interest rate and duration risk.

At the same time, investing in long-term bonds ensures stable returns even if interest rates decline in the future. A barbelling approach involves holding both short-term and long-term bonds. This strategy can provide a balance between liquidity and stable returns, making it an effective method for managing fixed-income investments.

5. The risks and benefits of international investing.

Domestic and international markets are often non-correlated. This means that the performance of securities and markets in one country move independently from those in another, which can help reduce overall portfolio risk. International investments may also lead to greater growth opportunities, as different regions perform better at different times.

However, investing in international markets also comes with its own set of risks. Currency fluctuations are a major concern for individual investors with a lower level of active management, as changes in exchange rates impact the returns on your investments. Consider investments that are hedged in U.S. dollars to mitigate this risk.

Emerging or developing markets are often more volatile than developed markets, which can lead to substantial volatility. Investors must be prepared for this. While both emerging and developed markets serve a purpose, it is often advisable for individual investors to avoid significant exposure to emerging markets.

6. Review and adjust your portfolio on a regular basis.

Regular reviews and adjustments are essential for maintaining a prudent investment portfolio. The financial markets are ever-changing and, similarly, your personal financial goals will change over time. By monitoring your portfolio, you can ensure that your asset allocation stays aligned with your investment objectives and risk tolerance.

When considering an investment, it’s crucial to ask why now is the opportune time to invest. Is the investment attractive in the long term, or is it a short-term play? You should also consider potential downside risks and think about what could convince you not to invest. Thinking ahead allows you to make informed decisions that align with your financial goals.

The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.


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