We write frequently about the value of diversification. Many believe it’s the only free lunch in investing. We think it’s an almost-free lunch, as it requires a bit of work to setup and maintain, but the results can be helpful in keeping you on the path to achieve your financial goals. First, we should define diversification: it’s the practice of allocating capital in a way that reduces the exposure to any one particular asset or risk. Put differently, it’s the practice of avoiding putting all eggs in one basket.
We believe that diversifying your portfolio is a key factor in success. In fact, it’s one of our three investment pillars (along with Patience and Selection). Here’s how you can make it work for you and your asset allocation:
1. Invest in Different Asset Classes
- Stocks: Include a mix of companies that have different exposures. Owning shares of United Parcel Service and FedEx (FDX) is not as diversified as owning FedEx and Walmart (WMT), at least when it comes to risk.
- Bonds: Consider purchasing government, municipal and corporate bond with maturities that are spread out over time.
- Real Estate: Real estate investment trusts (REITs) or direct real estate investments can provide both income, capital appreciation and tax benefits.
- Cash and Equivalents: Keep some of your portfolio in cash or cash equivalents for near-term needs.
2. Geographic Diversification
- Domestic and International Stocks: Invest in both domestic markets and emerging or developed international markets. Alternately, as we prefer at The Prudent Speculator, invest in companies that are U.S.-traded, but have revenue and business exposure in part or entirely abroad.
3. Sector Diversification
Spread your investments across different sectors such as Technology, Health Care, Financials, Energy and others. A key issue with many broad-based indexes is that they seem diversified owning 500 or more stocks, but the sector concentration is significant.
4. Different Investment Styles
Factor Investing: Invest in a mix of factors. We like Value stocks and Dividend Payers, while our fundamental framework reviews data points like cash flow to help unearth undervalued stocks that have potential for price appreciation. A key part of diversification is to find companies that look attractive across a variety of metrics, rather than zeroing in on one fundamental factor or characteristic.
5. Time Horizon Diversification
Short-Term vs. Long-Term Investing: Balance your portfolio with assets that have different time horizons, such as short-term bonds or stocks for easy access to cash, and long-term investments like stocks and real estate for capital appreciation.
6. Alternative Investments
- Real Estate: Invest in private real estate.
- Private Equity: Investors can directly invest in privately held companies.
- Hedge Funds: For those with specific risk and return objectives, hedge funds may offer unique strategies that improve your individual financial picture.
When employed thoughtfully, diversification is valuable in helping keep you on the path to investment success. Of course, individual situations vary and if you want to know more about diversification and how it can help you reach your goals, please reach out to us.
Kovitz Investment Group Partners, LLC (“Kovitz”) is an investment adviser registered with the Securities and Exchange Commission. This report should only be considered as a tool in any investment decision and should not be used by itself to make investment decisions. Opinions expressed are only our current opinions or our opinions on the posting date. Any graphs, data, or information in this publication are considered reliably sourced, but no representation is made that it is accurate or complete and should not be relied upon as such. This information is subject to change without notice at any time, based on market and other conditions. Past performance is not indicative of future results, which may vary.