Investing does not have to be complicated.
There are thousands of stocks, bonds, mutual funds, ETFs, and other investments available. But owning more investments does not necessarily mean you have a better portfolio.
A good investment strategy can often be built around a few basic ideas: spread your risk, own different types of investments, give them time to work, and keep the portfolio simple enough that you understand what you own and why you own it.
Start With Diversification
Most people have heard the phrase:
Don’t put all your eggs in one basket.
That is the basic idea behind diversification.
If all of your money were invested in one company, the success of your portfolio would depend heavily on what happened to that company.
Instead, you can spread your money across many different companies so that no single company has as much influence over the outcome.
But diversification can go further than that.
Diversify Your Diversification
Imagine owning 50 different companies, but all 50 are technology companies.
You own a lot of investments, but they may still be affected by many of the same things.
The same thing can happen with investment funds. Someone may own several different funds and appear to have a very diversified portfolio, while underneath the surface those funds own many of the same companies or follow very similar investment styles.
That is why we also want to diversify our diversification.
Instead of simply owning more investments, we want different parts of the portfolio.
That may include large companies and smaller companies, U.S. and international companies, stocks and bonds, and investments that approach the market in different ways.
Different pieces of the portfolio can respond differently as markets and the economy change.
And that is important because we do not know ahead of time which part of the market will perform best – or where the next problem will come from.
Preparing for What We Don’t Know
There will be periods when investments decline, sometimes significantly. Diversification does not prevent that.
What it can do is help reduce the amount of your financial future that depends on any one investment, market, industry, or investment style.
Some risks can be anticipated and planned for. Others cannot.
Economic conditions change. Industries fall in and out of favor. Different parts of the world experience different challenges. And occasionally something happens that investors simply did not see coming.
We cannot build a portfolio that eliminates every risk.
Instead, we can build one that does not require us to correctly predict which risk will appear next.
That is one of the most important jobs of diversification.
Give the Strategy Time to Work
Even in a well-diversified portfolio, not everything will perform well at the same time. In fact, that is partly the point.
There will often be something in the portfolio that looks disappointing compared with whatever happens to be performing best at the moment.
When large U.S. companies are doing well, international investments may look unnecessary. When stocks are rising quickly, bonds may seem unexciting.
A few years later, the situation may look very different.
The goal is not to constantly move money toward yesterday’s winner. It is to own a collection of investments that can work together through different environments and then give that strategy enough time to do its job.
Simplicity Is a Good Thing
Diversification does not require owning dozens of investments.
Sometimes adding more investments simply creates more overlap and more complexity.
A relatively small number of thoughtfully selected investments can provide exposure to thousands of companies, different parts of the world, different types of businesses, and different kinds of assets.
There is something valuable about that simplicity.
You should be able to look at your portfolio and understand, at least in broad terms, what you own, why you own it, and what job each part is supposed to do.
If a portfolio becomes so complicated that those questions are difficult to answer, adding more investments may not be making the strategy better.
The Goal
There is no perfect investment portfolio.
We cannot know exactly what markets will do next, which investment will perform best next year, or where the next period of difficulty will begin.
Fortunately, a good investment strategy should not require us to know.
We can spread our risk, diversify across different types of investments, keep the strategy understandable, and give it time to work.
The goal is not to own everything or predict everything.
It is to build a simple, diversified portfolio that you understand, that is designed to handle different market environments, and that you can stay with when conditions become uncomfortable.
Because ultimately, a good investment plan should do more than simply give your money an opportunity to grow.
It should also give you confidence in what you own, why you own it, and how the pieces are designed to work together.
And sometimes, that understanding is an important part of being able to worry a little less about what the market might do next.
Disclaimer: This content is provided for informational purposes only. It is always best to counsel with your financial advisor or your tax professional to ensure that you make the best decision for your circumstances.
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