Important Tips to Follow When Diversifying Your Stock Market Investments
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Diversification is an immensely important aspect of efficient portfolio management. By diversifying your investments, not only can you reduce the risk quotient on your portfolio but you can also safeguard yourself from the volatile nature of domestic and international markets.
Regardless of the investment instrument you choose, there is always a certain degree of risk that comes with it. Proper asset allocation can help you lower this risk to a great extent. Therefore, it is vital that you diversify among different asset classes and strike a balance between risk and return. This way, you can be better prepared to navigate across market situations and achieve your financial goals in the stipulated time.
Here are some other important tips that you must follow when diversifying your stock market investments:
1. Venture out but do not go too far
The prevailing wisdom behind ‘not putting all your eggs in a single basket’ still holds true to this day. So, you should never put all of your money into one stock or sector. Instead, consider purchasing stocks of a few companies, spread across sectors that you know, trust, and might even use in your daily life. For instance, instead of solely focusing on real estate, you can also consider pharmaceuticals, technology, etc.
However, while you spread the gamut of your investments, do bear in mind to keep a manageable portfolio. Do not invest in too many different stocks or companies if you do not have the time, money, or inclination to keep up with them. Empirical evidence suggests that investors should buy at least 15, and no more than 30, stocks to lower risk and yet be able to efficiently manage the portfolio.
2. Invest abroad
Somehow, many American investors are biased towards domestic securities. This could be because they are better informed about domestic stocks, or feel that there are fewer risks involved with them. However, to diversify your stock market portfolio, you need to leverage some international exposure as well.
Investing in diversified international stocks can protect your portfolio from potential market fluctuations and meltdowns. By spreading your money across stocks in different countries, your overall returns will remain balanced even if investments in a particular region do not perform well. In other words, a stock market crash in a country you have invested in will not affect your investments in other countries.
Moreover, in the present day and age, more and more economies in the world are growing to maturity, and international stocks are playing an increasingly large role in helping investors benefit from overseas growth. While the U.S. stock market still makes up for roughly 50% of total market capitalization, investing in stocks of foreign markets is gradually becoming a very intelligent step towards diversifying your stock market investments.
3. Understand your risk tolerance
When diversifying your stock market investments, it is crucial to understand investment risks and your tolerance level. Market risk, liquidity risk, concentration risk, and inflation risk are just some of the several risks that your principal amount can be exposed to when you invest in stocks. With such high stakes, you stand to lose a part or, in some rare cases, all of your invested capital.
Every individual can have a different tolerance to risk. Therefore, determining what you are comfortable with is essential. Higher risks do equate to higher possible returns, but if you push beyond your tolerance limit, things will likely turn sour for you in the long run.
On the whole, conservative investors should invest more in U.S. large-cap funds. However, if you want to be more aggressive, small-cap funds, international funds, and emerging market funds can also be considered as possible routes for diversifying your stock market investments.
4. Do not make emotion-driven decisions
Certain situations can cause massive deviations in stock markets around the globe and some investors are guilty of letting emotions influence their decision-making abilities at such times. In the past, many individuals have been known to make emotionally-charged decisions out of fear, greed, panic, or some other vested interests.
For instance, when the stock markets crashed due to the coronavirus outbreak, many investors panicked and sold or shuffled their stocks to avoid possible losses. While this may have seemed like a good decision at first, it turned out to be quite the opposite eventually.
With the passage of time, markets began to bounce back once again and volatile investments started stabilizing. Consequently, investors who had given into their emotions initially were left to rue the decisions they had made on the spur of the moment.
Ultimately, stock market returns can indeed fluctuate in the short-term owing to temporary situations like the 2020 lockdown. However, in the long run, investments usually balance themselves out and the overall returns are close to the initially estimated averages. Therefore, do not let emotionally-driven decisions get the better of you irrespective of prevailing circumstances.
5. Monitor your investments regularly
With more and more diversification, it can become quite difficult to keep track of all your stock market investments. Since the markets can be very volatile, any major event or happening in just about any corner of the planet can drastically impact the performance of stocks in every country.
For instance, in 2019, when the trade war was heating up between the U.S. and China, there were significant ramifications on the stock market in India. Stocks were rising and falling constantly based on changing reports in the daily news. More recently, the coronavirus outbreak caused major upheavals in all stock markets across the world.
Owing to the sensitive nature of stocks, it would be prudent for you to monitor your investments and keep track of major national and global events that can affect your stock market portfolio, either negatively or positively. By doing so, you can safeguard your diversified investments by being prepared beforehand.
To sum it up
Diversification is the cornerstone of any investment portfolio. As far as stocks are concerned, the broader the scope of diversification, the more stable returns will usually be, and the lesser risk an investor will have to contend with. In the end, diversification cannot guarantee better returns or fewer losses, but it can help you achieve your long-term financial goals.
If you require any assistance with diversifying your investment portfolio, get in touch with top financial advisors in your area.