We have all heard the phrase, “Don’t put all of your eggs in one basket,” but what does it really mean? If you put all of your eggs in one basket and then drop the basket (or it is stolen by the Easter Bunny), you will lose of all of your eggs. Similarly, if you invest all of your money in one company stock or single asset class and that company fails or that asset class underperforms, you have “lost” all of your money. In the investment world, this problem is solved through diversification and managing the risk exposure in your portfolio.
How many eggs go in which baskets?
Asset allocation is the first step in creating a diversified investment portfolio. Asset allocation means deciding how your investment dollars should be allocated among broad asset classes such as stocks, bonds, alternative investments, and cash equivalents. Diversifying your investment mix amongst the various asset classes is a key tool for managing market volatility. Because asset classes often perform differently under different market conditions, spreading your assets among them has the potential to help reduce your overall risk exposure. The underlying principle is that different asset classes have shown different rates of return and levels of price volatility over time. Also, since different asset classes often respond differently to the same news, your stocks may go down while your bonds go up, or vice versa.
So how much do you put in each basket? If you have too much allocated to cash, then you run the risk of losing money to inflation. If you have too much allocated to stocks, you may be losing sleep at night dealing with the daily fluctuations of the market. The answer is different for everyone. You need to consider your tolerance for risk, your financial resources, your long-term goals, and your investment timeframe to figure out the appropriate mix for you.
What Diversification is NOT
Spreading your assets amongst several different investment advisors or brokerage houses is NOT an effective diversification strategy, especially if all of those accounts contain similar holdings. For instance, if you use three different brokerage firms to house your investments and they all invest in large cap stocks – your eggs are still in the same basket.
Work with a financial advisor who you trust to figure out the best place to put your eggs to protect against market volatility, inflation, and of course, that mischievous Easter Bunny.
For more information, visit our website at www.makinglifecount.com or contact Jamie Bosse at 913-345-1881 or firstname.lastname@example.org.