Anyone who has dipped their toes into the waters of the investment world has probably heard about the many benefits of a diversified investment portfolio. “Don’t put all your eggs in one basket” is as good advice today as it ever has been. But very few people understand just how wide the range of investment options is and how much easier it has become in recent years for ordinary investors to diversify their portfolios. Here are a just a handful of the options that are available to most investors.
Mutual funds are one of the most popular investment options. Because mutual funds invest across a wide range of assets, they are in a way already diversified. Each fund decides to invest across a wide variety of stocks, a handful of bonds, and maybe hold some cash. Some investors may think that just investing in mutual funds offers adequate diversification, but that’s not the case. Many mutual funds are very stock-heavy and thus highly sensitive to moves in stock markets. If the bulk of your savings is in mutual funds, a stock market crash could cost you much of your savings.
Index funds are similar to mutual funds in that they invest in a wide variety of stocks, but they’re different in that they attempt to match the performance of various stock indexes such as the S&P 500, the Russell 2000, etc. The benefit of index funds is that investors can gauge pretty easily how the fund should be performing, and because the fund is not as actively managed as a mutual fund it should also offer investors a lower expense ratio. The downside, though, is that index funds won’t offer better returns than the overall market.
Exchange Traded Funds
Exchange traded funds (ETFs) are funds that own assets such as stocks, bonds, or commodities and offer investors shares to divide up ownership of those assets. ETFs have become a very popular method for investors to begin investing in commodities such as gold, oil, foreign stock markets, etc. that otherwise would have been out of reach to ordinary investors. While commodity ETFs won’t offer all the advantages of actually investing in commodities, they do provide an opportunity for investors to diversify their portfolios, and their popularity is growing all the time.
There are many options out there for investors to open brokerage accounts to trade individual stocks on their own. Some investors really get a thrill out of analyzing balance sheets and income statements, identifying undervalued stocks and investing to make sizable returns. But not everyone has the time to engage in that type of investment, and one of the risks is that you may end up so focused on maximizing your returns that you forget to adequately diversify your portfolio.
Bonds are debt instruments issued by governments and corporations. Investors who purchase bonds are loaning money to the issuer in the hope that they will receive interest payments and eventually be repaid their principal. The higher the risk of default, the higher the interest rate the bond pays. Bond risks run the gamut from AAA-rated bonds that are supposed to be super-safe to junk bonds that may run you the risk of losing your money.
A certificate of deposit, or CD, is a time deposit that an investor makes to obtain a higher rate of interest than would be achievable in a savings account, with the drawback that the money invested in a CD is not immediately available for withdrawal. CDs can have terms ranging anywhere from one month to five years. Investors who want to withdraw their money from the CD before the term of the CD has expired normally have to pay an early withdrawal penalty. Because CD rates have dropped so low in the current low interest rate environment, they have become a less popular form of investment for many people. The rate on a 1-year CD currently averages around 1.7%.
Cash, Checking, and Savings Accounts
Most people don’t realize it, but a savings account is an investment in which the saver lends money to the bank. The depositor is the creditor and the bank is the debtor. Federal deposit insurance has obscured that understanding, so that people think of it as a risk-free action rather than an investment. Holding cash or deposits in bank accounts is good if you need a good amount of immediately liquid assets. But holding too much will inevitably erode the value of your savings since they won’t keep pace with inflation.
Many Americans still think of their homes as investments. With home price appreciation continuing to rise in many major metropolitan areas, homebuyers think they’ll be able to sell their house in the future for far more than they paid for it. Still other homeowners purchase second homes as vacation homes, or inherit a parent’s home or apartment and rent it out. Others try to engage in real estate speculation by fixing up houses and flipping them. Some will buy land in the hope that the value will appreciate as developers scoop up more and more to build new homes.
Real Estate Investment Trusts
But all of those are very time- and capital-intensive ways to invest in real estate. A newer method of real estate investment is investing in real estate investment trusts (REITs). These trusts operate in a similar manner to mutual funds, allowing individual investors to own shares in the trust. REITs focus on owning income-producing real estate such as commercial office space, and pass on the real estate income to the trust’s investors. Those REITs that are traded on open exchanges allow investors to begin diversifying their portfolios by gradually increasing their exposure to real estate investments without having to spend hundreds of thousands of dollars all at once.
Precious metals such as gold and silver are another popular means of diversification. Investment in gold and silver can take many forms, such as purchasing and holding gold and silver coins, investing in gold and silver ETFs, purchasing gold holdings at various mints that offer custodial services, or investing retirement funds in a gold or silver IRA. Precious metals offer protection against financial turmoil since they hold their value even when stock markets decline. Gold IRAs even offer the tax advantages as traditional IRAs, allowing you to benefit from gold’s protective status while still enjoying the same tax benefits as traditional retirement options.
Regardless of how you choose to diversify your portfolio, your options are probably far more numerous than you realize. There’s no need to stick just to stocks and bonds, leaving yourself subject to the whims of Wall Street. If your portfolio is invested too heavily in one type of asset, you owe it to yourself to start looking into diversifying your portfolio today.
Trevor Gerszt is America’s Gold IRA Expert, CEO of Goldco Precious Metals, and holds a position on the Los Angeles board of the Better Business Bureau.
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