Rowland Goddard, Staff Writer
The financial markets in 2020 proved that the current investing landscape is extremely volatile. Momentum trading is evident at every corner of the market. Stock growth/losses are severe and happen quickly. These market trends can be connected to advancements in technology allowing the transfer of information to reach a greater number of individuals in a quicker period of time. No longer do you need to be a Wall Street broker to be in the know.
The New Investor
Trading has become more accessible than ever, and retail investors are taking the markets by storm. This past week, these investors pushed GameStop stock (GME) to $483 when it had been trading at just $43 a few days prior. As new investors test their luck with the markets, it is important to recognize the importance of keeping your portfolio diversified.
What is a Diversified Portfolio?
A diversified portfolio includes a mixture of stocks, commodities, and fixed-income investments. It is valuable to include diversification within your portfolio because these investments act differently to economic events. For example, one stock may fall and another may rise due to the same news in the market. This situation can be linked with unsystematic risk. This type of risk is inherent in a specific company or industry. Through diversification, we can spread the risk across many different sectors/industries thereby reducing the total risk.
The first step to diversifying your portfolio is determining the amount of risk you want to be exposed to. Exposing yourself to greater risk will increase the volatility which could achieve greater returns. Conversely, by reducing the unsystematic risk of your portfolio, you will limit the volatility of your returns. This will produce consistent returns over time which can help you budget your finances.
The amount of risk an investor takes on is based on how active/passive the investor is as well as the size of their portfolio. An aggressive investor will be active in managing their portfolio and thus can take on more risk. On the other hand, a conservative investor will passively manage their portfolio and should parallel their returns of a major index. This approach will expose them to a smaller amount of risk. In general, a smaller portfolio can be exposed to greater risk as potential losses are less impactful, whereas a larger portfolio will subject itself to less risk.
Organizing your Portfolio
Aggressive investors should allocate their portfolios primarily in domestic and foreign stock as the possible returns are greatest with these assets. This should equate to roughly 60-75% of the total portfolio value. The remainder of this investor’s portfolio should comprise of bonds and short-term investments. A conservative portfolio should consist of 60-75% of safe investments such as bonds and money market funds. The remainder of the portfolio can be made up of stock. Finally, a balanced portfolio will consist of 50% stock and 50% bonds and money market funds.
Regardless of the type of investor you are, and how much risk you wish to take on, it is important to diversify your portfolio. As the saying goes: you don’t want all your eggs in one basket.