The basic steps are:
Essentially, diversification means not putting all your eggs in one basket. By dividing your money among different investments, you can help reduce the impact of poor performance from any one investment. Let's say you want to diversify your investment portfolio. You might decide to put some of your money in stock investments, but also a portion in short term investments and another portion in bonds. Because these three categories generally perform differently during economic cycles, strong performance in one or two categories may offset poor performance in a third.
Any time your investment goals or financial circumstances change, or when economic conditions shift, you should take a look at your portfolio and see if it needs to be updated. Even if these factors haven't changed, it's a good idea to review your portfolio at least once a year. When reviewing your portfolio, consider these two points:
PERSONAL GOALS. How is your portfolio performing from the viewpoint of your personal goals? Are you comfortable with any price fluctuations that may have occurred? Are you getting the results you expected?
BENCHMARKS. How are your investments performing compared with others in the same category? If your stock fund is down 2%, it may not seem like a good performer. But, if the stock market as a whole is down 7%, that could change the picture. Similarly, a stock fund that's up 12% may look terrific, but not if the market is up 20% over the same period.
If you find yourself unhappy with the results of your investing, or uncomfortable with fluctuations in the value of your portfolio, you may want to go back to the questions you asked yourself when you were first planning your investment strategy. Do the same answers still apply?
Remember, fluctuations in investment value are a fact of life
for stock and bond investors. The stock market can be down
for periods of a year or more. That's why it's important to
match your investment portfolio to your time frame, and also
to consider your feelings about risk.
There are several benefits that mutual funds provide in lieu of holding simply stocks and bonds:
Asset allocation can help you avoid being too heavily concentrated in one particular area when markets fluctuate. It is the specific mix of investments in your portfolio; stocks, bonds, and cash. Being too heavily invested in long-term bonds can be disastrous when interest rates rise, and having too many equities during market downturns can be equally destructive. By taking the advice of a financial planner and using allocation tools, you can enhance returns and adhere to your personal risk tolerance levels.
Don't be intimidated by those who say that you must invest painfully large amounts of money in order to retire comfortably. Much depends on your age of retirement and lifestyle choices. Consider, for example, investing as little as $192.28 per month. After 25 years, earning a 9.5% rate of return, your portfolio would be worth $250,000. Be aware, however, of the inflation rate, which has historically run at about 3%.
