Diversification in your investment strategy is all about managing risk, says Brandon Strong, Managing Partner at Stonebridge Wealth Strategies.
“When you’re building a portfolio, you need to understand how each investment fits in with your overall goal,” Strong says. “You need to understand the correlation of different asset classes and how they diversify a portfolio. Diversification is about managing risk. It’s not a strategy to make more money.”
The complexities of diversification can easily lead investors to have a false sense of security about their wealth building strategy. The long-term effect of this disconnect is it becomes more difficult to meet long-term goals such as putting your kids through college, planning your retirement and passing on your wealth to your heirs.
“You have to pay attention to what you own as an investment, why you own it and how it all fits together,” Strong says.
Smart Business spoke with Strong about the best approach to diversifying your investment portfolio.
How does the use of multiple asset classes help you diversify your investment portfolio?
An asset class in its simplest form could be equity, or any stock that you might own. It could be fixed income, which could refer to an entire bond market. From there, you can break those two categories down even further.
For stocks, you can look at it in terms of international versus U.S. asset classes and then small, medium and large companies that you’re investing in. Each one of those asset classes reacts in its own way to different economic data.
When you blend them into a portfolio, you are often helping to address your overall risk because you have assets that react differently to what is happening in the economy. On the bond side, you could break it down to U.S. government bonds, corporate bonds, municipal bonds, foreign government bonds and a variety of other categories beyond these segments.
What people often forget to add to their portfolio is investment in asset classes outside of these categories. Real estate and commodities are two segments not highly correlated to those asset classes that could bring down the overall movement or volatility of your portfolio. As an investor, you need to regularly balance the level of risk in your portfolio.
There’s a big difference between saving money and putting it into an investment account versus when you get to retirement and you now need to distribute money out of the account. Your strategy can be driven by two philosophies: What’s your risk tolerance? What level of risk do you need to achieve your goal?
Where do people get into trouble trying to achieve investment diversity?
You might hold one brokerage account with 15 different mutual funds, but each one of those funds is fairly similar. Even though you’re diversified in the number of mutual funds, they all basically do the same thing, so you’re not diversified within that asset.
Conversely, it’s typically unwise to use one mutual fund or one money manager to fit into every different asset class. Another risk would be to have your entire net worth and future income tied up with one particular source, such as your employer through stock ownership and a pension plan.
Diversification is not as much about the assets you own as it is about how those assets fit together to help you meet your long-term wealth building goals.
What’s the key to having a good investment strategy?
You always start with a financial plan and make sure you know where you need to be at the end of your goal.
Do your homework and understand where you are in relation to your goal before you make any changes. Talk to a financial professional who can help you understand next steps and determine how environmental changes could affect your asset allocation or diversification strategy. ●
Financial Professionals of Stonebridge Wealth Strategies are registered representatives who offer securities products through AXA Advisors, LLC, a registered broker-dealer and member FINRA/SIPC, investment advisor representatives who offer financial planning and investment advisory products and services through AXA Advisors, LLC, an investment advisor registered with the SEC. Annuity and insurance products offered through AXA Network, LLC. AXA Network conducts business in CA as AXA Network Insurance Agency of California, LLC, in UT as AXA Network Insurance Agency of Utah, LLC, in PR as AXA Network of Puerto Rico, Inc. Asset allocation, diversification and rebalancing do not guarantee a profit or protection against loss. Asset Allocation is a method of diversification which positions assets among major investment categories. This tool may be used in an effort to manage risk and enhance returns. AGE- 116266(06/160(Ext.06/18)
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