Even if you know only the bare basics of investing, you’ve probably heard that you need to “diversify” your portfolio — the technical term for not putting all of your investing eggs in one basket.
Seems easy enough. Avoid sinking all your money into Google stock and you should be set, right?
“Diversification is not just about having a bunch of different mutual funds or ETFs or even stocks,” Bob Gavlak, CFP and wealth adviser with Strategic Wealth Partners in Columbus, Ohio, told Business Insider. “A lot of people will say, ‘Yeah, my portfolio is diversified,’ and then I look at their portfolio and they have 10 different mutual funds, but all 10 of those mutual funds are large cap value mutual funds or something like that.”
“Just because you have a bunch of mutual funds or ETFs does not mean you are necessarily diversified the way that you should be depending on your investment goals.
“The importance of diversification is that when the markets work — and they work in cycles — certain asset classes or certain pieces of the world economy are going to be up when others are going to be down. The goal is to minimise your overall exposure to one asset class so if that asset class does not perform as well, there are others holding up the portfolio or keeping you more in line with your long-term investment goals.”
Charles Schwab portfolio consultant Sean Moore previously told Business Insider he regularly sees this mistake. Investors put together a “collection” of investments rather than a portfolio. “You find that because investors don’t understand what’s going to serve their best big-picture objectives, and they purchase or select investments based on factors like past performance or names they recognise,” Moore said.
Moore pointed out that “funds of funds,” like target date funds, are available for investors who aren’t completely secure in their own diversification strategies. “They’re sometimes referred to as market or balanced funds,” he explained. “Obviously it’s not tailored to you specifically, but the idea is it’s pre-diversified.”
Gavlak recommended investors ask themselves, “What do I need my investments to do for me in order to be successful?” From there, he said, you can better develop an investment strategy that’s properly diversified among the appropriate set of asset classes rather than through different funds that may overlap.