Why and How To Diversify Your Investments

If the stock market’s wild swings lately have left you feeling more than queasy, you’re not alone. There’s not a reputable economist alive who can reliably predict what the market will do in the coming year, or whether we’re headed for a recession (though we’re long overdue for one).

Despite the dizzying highs and lows on Wall Street, we’re not yet officially in a bear market, defined as a 20 percent drop from recent highs. Nevertheless, the average person who has anything invested in the stock market needs nerves of solid steel to keep calm and carry on.

Billshark has often counseled you that slow and steady wins the race, at least in investing for the long term. Unless you’ll be retiring in the next year or two, there’s no need to panic. Just the opposite, in fact. Financial advisors encourage younger investors to totally ignore stock market swings because, over time, stocks on average outperform any other investment you can make. As you get closer to retirement age, you’ll want to gradually move more of your investments out of stocks and into less risky investments, such as bonds. But if you have years or even decades, the smart move is to not react to market volatility.

What “diversify” means

There is a caveat, however. No matter what your age, you shouldn’t have all your eggs in one basket; in other words, your investments should be diversified. You’ve heard that word, but maybe you didn’t know exactly what it meant, so let us explain that now, and show you how to diversify intelligently.

Here’s what diversifying isn’t: having 20 different stocks.

Here’s what diversifying is: having a mix of investments in small-cap and large-cap stocks, index or bond funds, real estate, international investments, and cash.

Once you’ve set aside readily available cash for emergencies and at least a six-month cushion in case of job loss, you can move into other investments.

Why to diversify

The reason financial advisors constantly preach diversification is because it spreads out the risk of investing. Suppose, for example, that in the summer of 2008 you had 100 percent of your investments in stocks, primarily banks and financial institutions. By the spring of 2009, you’d have lost everything. But if you had a portion in stocks, as well as a portion in bonds, you would have at least held on to some of your money. This is known as asset allocation: investing in different types of assets that counterbalance each other. In the case of stocks and bonds, for example, when one of those assets loses value, the other tends to gain. So it pays to know how to diversify.

How to diversify

The best way to do this is to start with your age. The accepted rule of thumb is to subtract your age from 100 and put that percentage into stocks, and the remainder into bonds. For example, if you’re 30 years old, put 70 percent into stocks, and 30 percent into bonds.

But that’s just the beginning. You should then break that down even further. Large-cap stocks are those shares of a company with a market capitalization (the price of a stock multiplied by the number of shares outstanding) over $5 billion. Small-cap stocks, as you might imagine, are companies with a market capitalization smaller than that. To simplify things, invest in large companies like Johnson & Johnson and Intel and smaller companies like those you know and do business with regularly, like Angie’s List or Sonic.

Then you need to diversify even more. Look for a mix of, for example, index funds (funds that are indexed, or tied to, the performance of the S&P 500), retail stocks, banking stocks, and international stocks.

Aren’t mutual funds enough?

You may have heard that investing in mutual funds is the safest way to invest. These are a type of investment program that pools money from several investors that are then managed by a professional who can do the research on diversification for you. Most mutual funds focus on one of four main categories: money market funds, bond funds, stock funds, and target date funds.

According to Investor.gov, a service offered by the U.S. Securities and Exchange Commission (SEC) (and a valuable tool for learning about investments):

“All funds carry some level of risk. With mutual funds, you may lose some or all of the money you invest because the securities held by a fund can go down in value. Dividends or interest payments may also change as market conditions change.”

In addition, a mutual fund’s past performance doesn’t indicate future returns, although it can show you how volatile or stable a fund has been over time.

So in general, it makes sense to acquire a basic knowledge of investing, and not leave it to “the professionals.” If investing were a science, you wouldn’t be seeing the recent huge losses on Wall Street. Sound financial investment isn’t a “set it and forget it” proposition. You have to manage your investments the way you’d manage your career. And since financial literacy isn’t taught in schools, you have to teach yourself. That’s what Billshark advises you to do to get the most out of your investments and have them work for you.

One group of professionals who can help with your finances are the sharks at Billshark. We know the ins and outs of the overcharges and hidden fees in your bills, and can help you save hundreds or even thousands of dollars. So let our sharks take a look and see what we can do for you.