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By: Sophia Young
It’s no secret that the past two years have been difficult for investors. With the pandemic raging across the globe, many traditional markets have suffered, and many people with plans to build wealth have been forced to re-evaluate their investment strategies on the fly.
Spreading your investment portfolio across different asset classes can minimize your risk and build wealth over the long term. So, what are the best ways to diversify your investment portfolio in 2022?
We all know the adage of never putting all your eggs into one basket. And when it comes to investing, diversification is key to building a strong investment portfolio that can weather any storm.
There are two main reasons to diversify:
To minimize risk – By spreading your investments across different asset classes, you can minimize your overall risk, since events that impact one class might not impact another. For example, while stocks might be struggling, bonds might be doing well. By investing in both, you can smooth out the ups and downs of the market and minimize your risk.
To maximize returns – While diversification won’t guarantee that you’ll make money, it will give you a better chance to earn higher returns over the long term. This is because you’ll be able to take advantage of different market conditions and invest in areas that are doing well.
As with nearly all strategies, the best approach can vary from case to case. Think about these things first before deciding how to best diversify your investment portfolio:
Start with your goals – The first step is to have a clear idea of your investment goals. Are you looking to grow your wealth? Save for retirement? Or both? Once you know your goals, you can start to think about the best way to achieve them.
Consider your time horizon – Your time horizon is the amount of time you have to invest. This will play a big role in how you diversify your portfolio. Those with longer time horizons can afford to take more risks, as they have time to recover from any short-term losses.
Think about your risk tolerance – Risk tolerance is the amount of risk you’re willing to take on. This is a personal decision that only you can make, based on various factors, such as your long-term plans, financial health, or temperament.
Once you have a clear idea of your goals, time horizon, and risk tolerance, you can start to think about the best way to diversify your portfolio.
Tips on diversifying your portfolio
Diversifying your investment portfolio requires you to pick an asset allocation model that dovetails with your personal goals, time horizon, and risk tolerance. Choosing one doesn’t commit you to that strategy in perpetuity. You can take parts from all four models and use them to create a hybrid strategy that’s tailored just for you.
Looking for a steady income?
First, you’ll want to consider a mix of assets that offer both stability and growth potential. While you don’t want to risk too much, you also don’t want to miss out on small opportunities to capitalize on market growth.
Second, it’s important to remember that even the best asset allocation model will involve some degree of risk. If you’re on a tight budget, we suggest using a financial plan as well as expense management tool to help you keep track of your spending.
Prime examples of assets for this type of portfolio include:
Municipal or corporate bonds
US Treasury securities
Well-performing, dividend-paying stocks.
Need some income but also want to grow your wealth?
For your needs, a similar model as above can be followed with some adjustments. The biggest difference is that you’ll want to put a greater emphasis on growth-oriented investments.
Your income will generally come from dividends from equity investments in stocks, as well as from interest payments on bonds. You may also reinvest dividends to purchase additional shares, which can result in compound growth over time.
Growth investments typically come with more risk than income investments, but they also offer the potential for higher returns.
Want to expand your wealth?
Just like the model above, an asset allocation model geared toward wealth growth will favor investments that have the potential to generate high returns.
It’s still possible to hold a few dividend income stocks in this model, but the vast majority of assets should be on companies with massive potential upside—these companies typically have no plans of paying out regular dividends to shareholders.
Want to expand your wealth as fast as possible?
An all-out approach to building wealth requires counting on high-return/high-risk equities and forgoing any income today in favor of huge growth opportunities in the future.
This portfolio would likely be made up mostly of small-cap stocks, penny stocks, and other high-growth/high-risk investments. The idea is to find a few companies that have the potential to explode in value and ride them to the top. Of course, this approach comes with a high degree of risk—you could easily lose everything you invest.
Here are a few examples of high-risk/high-reward investments:
Upstart companies – Companies who burst into the scene with a new product or service
High-growth small-cap stocks – Small companies with high potential for rapid growth
Options and futures contracts – Derivative instruments that can be used to speculate on the movement of underlying assets.
Diversifying your investment portfolio is one of the smartest things you can do to protect and grow your wealth. By allocating your assets among different asset classes, you can minimize your overall risk while still allowing yourself to achieve strong returns. Whether you want to grow your wealth slowly and steadily or go for broke with high-risk/high-reward investments, there’s a way to diversify your portfolio that’s right for you!