In finance, you should diversify your investment portfolio by reducing risk by investing in a variety of assets. Typically, this means asset allocation. Asset allocation is an investment strategy to balance risk and reward by adjusting the percentage of each asset in an investment portfolio according to your risk tolerance, goals and time frame. Are you diversified?
My investment strategy
How do you make your investment decisions? It should start with your financial goals! Before you can make investing decisions, you need some savings to invest. I always make savings a priority. I start with savings as my main financial goal and everything else has to fit with that goal. When I was much younger, I started with ten (10) percent and it grew from there. My choice of investments was income (rental) property because it produced current income and capital gains.
Income property is residential or commercial property that earn income through renting or price appreciation. It can be a home, apartment, apartment building, condominium or commercial property such as a shopping center or industrial property. You can earn current income and/or price appreciation. You can invest in income property by buying a variety of property or a mutual fund (REIT). Other ways of investing in the real estate industry are mortgages, housing, construction, financial institutions to just name a few.
Real estate or income property was not my only investment, but it was my most successful one at the time. Before I started investing in income property, I started with stocks/bonds, antiques, commodities, art, stamps, coins and collectibles. My financial strategy was multiple income streams before it became fashionable. I did not invest the term, but it came from experiencing many ups and downs of the various markets. I never wanted to depend on just one source of income when it could be upside down.
What should you do?
I remember receiving good advice about not concentrating your wealth in just a few stocks. The specific advice was no stock should represent more than 5% of your portfolio. If you expand that advice to encompass your entire investment strategy, that no asset class should represent a significant investment, you are on the right tract. Investing is personal and you have to include all of your investments including Social Security, pensions and brokerage accounts in addition to your IRAs
Although I do not include my residence in my investments, it is still an investment! My reasoning is I do not plan to cash out or use a reverse mortgage and I have to live somewhere. I will shortly (less than three years) have my mortgage paid off. I will celebrate this occasion, but I will also have a huge (over $500K value) asset just sitting there. I have a line of credit on my property to access this equity for short term borrowing and investing.
My reasoning is real estate is very illiquid and cannot be sold in a day. I consider my line of credit as my emergency fund or back up cash flow if necessary. I can use it to take advantage of short term investment opportunities too. This is an asset that will grow more over time and I wanted use some of the equity. My last option is to move out and rent out my residence and let the income pay for a luxurious apartment. Again, I like having multiple income streams or choices, don’t you?
How to determine your asset allocation? Your stock market asset allocation should include large, mid and small cap stocks, international, emerging markets, fixed income, money market and real estate investment trusts (REITs). All of these investments have risks and rewards depending on your risk tolerance. Depending on your risk tolerance you may select anything from a conservative to a very aggressive portfolio asset allocation. It should reflect your risk tolerance and needs in retirement.
Your asset allocation should be broad enough to let you sleep at night. You definitely do not want to run out of money in retirement! What is your plan B, if the market loses 10-20%? Would you have to change your lifestyle or standard of living? The stock market has it cycles of bull and bear markets. Some may refer to it as boom and bust or periodic corrections. Whatever the name, you need to plan for it. If one segment of the market such as large cap or tech stocks go down, other segments probably will not.
How much can you lose before you will have to make significant changes to your lifestyle? Use that number to determine how much you should invest in each asset class. I use these eight (8) classes except for fixed income and some others to invest my portfolio. Since investing is personal, I decided that Social Security and my pension will be my fixed income portion of my portfolio. In addition, I added to my seven (7) choices technology, healthcare and biotech companies.
Healthcare traditionally is a low risk investment and I balance it with a high growth investment in biotech. My healthcare mutual fund year to date return is eleven (11.07%) percent and my biotech stock was three hundred (300%) percent for the last twelve (12) months. My newest biotech has a forty (40) percent return in four (4) months. Will this continue? Probably not! That is why it only represents fifteen (15%) percent of my portfolio.
Investing is personal! Your investment strategy is probably different from mine, but you should spread your risk in the various classes based on your risk tolerance and financial goals. Diversification should not stop there either! Do not have all your assets in the stock or real estate market! Our most recent recession/depression showed us that was a risky strategy. If you invested at the height of the market, you are probably still feeling the pain of that decision. A diversified portfolio over time is by far the best asset allocation. Diversify your investments to meet your financial goals!
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