When asked how their assets are diversified, most people respond by indicating how much of their portfolio is divided between stocks, bonds, and cash. But looking at your overall financial diversification means more than simply looking at your investment portfolio - you need to examine all your assets. Some items to consider include:
- Your most significant asset is probably your ability to earn an income
The predictability of that income will have a significant impact on your financial situation and how much money will be available to save toward your financial goals. If you work for a company in a volatile industry, your spouse might want to seek employment at a more stable company. No matter where you work, don't purchase too much of your company's stock, even if it is through a 401(k) plan. You may even want to avoid stocks in related industries. Since your current and future income potential is closely tied to the company you work for, you don't want your income as well as your investments to be overconcentrated in one company. That way, if your job is jeopardized due to problems at your company, hopefully your investments won't be declining at the same time.
- Keep an eye on the outlook for your home's value.
Your home's appreciation potential is usually tied to economic growth in your area. If your area is dominated by a certain industry, the prospects for that industry can also impact your home's value. Thus, you may not want to own stocks in that same industry.
- Adequately diversify your investment portfolio.
Typically, you do not know which asset class will perform best on a year-to-year basis. Diversification is a defensive strategy - it helps protect your portfolio during market downturns and helps reduce your portfolio's volatility. Diversify your investment portfolio among a variety of investment categories, such as stocks, bonds, cash, real estate, and other alternatives. Also diversify within investment categories.
- Consider international investments.
Since U.S. stocks have outperformed international stocks for an extended period, international investments have gone out of favor. But no one knows whether this trend will continue in the future, so it may be prudent to include international investments in your portfolio. Before investing in international stocks, assess how much of your portfolio to allocate to this asset class, which will depend on your risk tolerance, time horizon for investing, and comfort level with foreign investing. Keep in mind that international investing may not be suitable for everyone. In addition to the risks associated with domestic investing, international investing has unique risks, including currency fluctuations, political and social changes, and greater share price volatility.