The recent market volatility, while not unexpected, has certainly been hard for any investor to digest. If you are feeling a tad queasy, you aren’t alone.
It’s an apt moment to pause and remind ourselves of the importance of diversification to help your portfolio ride through market turmoil.
What is Proper Diversification?
While attempting to teach my youngest daughter about nutrition over the summer, I pulled up the nutrition wheel. As I showed her the various food groups, I was reminded of a diversified portfolio with all its asset classes.
Arguably the most overused word in investment jargon, diversification is not simply about holding more assets. It is about paying attention to how the different parts of your portfolio work together. It’s part art and part science, like so many things in life, and takes some careful thought to make the right choices.
Think of it like maintaining a balanced diet—one food isn’t going to give you all the nutrition you need.
Asset Classes as Food
Asset classes are your basic food groups—carbs, proteins and vegetables. As with food, each asset plays a different role.
At its most basic, you have three components: stocks, bonds and cash. Stocks are generally riskier than bonds, but you can potentially see greater gains over time. When stocks decline, bonds have generally held up better and often delivered positive returns. And then there’s cash, which many investors use to preserve capital for a major expense, like college tuition. You may want to hold a blend of all three depending on your goals.