What is the real point of diversification in investing? How might this change the way you are allocating your portfolio and are picking investments and advisors?
If you’ve even looked into investing for five minutes you’ve probably heard about the importance of diversification. It is important. Vital even. Yet, many talk about diversification, or try to diversify without really understanding why and what makes diversification good, versus useless diversification strategies.
The Biggest & Most Common Diversification Mistake
The classic mistake that investors make here is going to a stock broker or other form of investment advisor who tells them that it’s impossible to know what investments are going to perform well or not. So, the solution suggested is often to invest a little bit across dozens and often hundreds of stocks and funds. Just blind investing, hoping that something will pay out.
Typically the investor has little understanding of exactly what their money is going into, and the fundamentals of those underlying investments.
Worse, they really don’t get any true diversification at all. Their money is mostly dumped into publicly traded stocks and funds, which often all move together on emotional or automated trades, which offer them little true diversification from any fluctuations.
Diversification is important, but you have to know why you are doing it.
Achieving Multiple Goals
One of the chief but often overlooked reasons for diversification is to simultaneously achieve multiple goals.
- Income generation
- Wealth preservation
- Wealth growth
Income is essential. Even if you don’t plan to live off of your investment income yet, you never know when you might need to. It should already be in place, before you need it.
The number one rule of investing is not to lose money. If you lose your capital, then you have nothing to invest with or recoup your losses with. So, investing to protect your gains should be a priority as well. Return of investment is a more important ROI, than any promises of return on investment.
Of course, between inflation and taxes, you also have to constantly be growing your wealth. So, a part of your portfolio should be pushing growth. This can yield lump sum gains to add to your nest egg and net worth.
Consistency, Planning & Reliability
One of the most important reasons for diversifying well is gaining the confidence that your overall investments will produce consistent and reliable results. You need this to be true in good and bad economic times. You need recession proofing, while maintaining the ability to benefit from upside potential too.
This in turn will do wonders for your ability to plan for the future in all areas of life and finances.
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