Portfolio Diversification 101: Why It’s Important To Diversify Your Investments

By: Jan Paul C. Ferrer

 

“Diversifi cation” is probably one of the fi rst terms you see whenever you read about strategies for smart investing. But are you clear on exactly what it means to have a diversifi ed portfolio and why you should care?

Diversifi cation Defi ned

Diversifying your investments simply means making sure all of your money isn’t in just one fi nancial “basket”. Instead of investing in a single security, diversifi ed investors put their money into a variety of different stocks, bonds, mutual funds and exchange-traded funds (ETFs).

The idea is that if one of your investments goes down in value, there’s a good chance that another investment will go up in value. In this way, diversifi cation helps you keep your fi nancial life in balance. Diversifying may help you earn a little more on your investments, but the greater value is that diversifying helps reduce your risk of losing money.

What Kinds of Investments Make Up a Diversifi ed Portfolio?

There are many different ways to diversify your money. The most basic type of diversifi cation is by asset class. For example, your investments might be comprised of 70% equities (investments in stocks) and 30% bonds (fi xedincome- type investments). The exact diversifi cation approach you use will depend on your time horizon—when you’ll need to withdraw your money— and your risk tolerance.

You can also diversify your investments using a mix of other factors:

• Geography: You could invest in both U.S.-based and international funds. Within your international funds, you could diversify further by investing in both established fi nancial markets and less-developed countries (known as “emerging markets”).

• Investment style: One mutual fund or ETF might focus on investing in stocks or funds that are currently undervalued—a strategy known as value investing. Another fund might focus on investing in companies that have a consistently strong earnings record. Owning a mix of funds that adhere to different investment strategies is another way to add diversifi cation to your portfolio.

• Company size: In the investment world, companies are placed into different stock groupings based on their market value. Companies with a very high market value are considered “large-cap” companies, mid-range companies are “mid-caps”, and lower-valued companies are “small-cap” fi rms. When you diversify your portfolio by company value, you might invest in a mix of large-, mid- and small-cap stocks or stock funds.

• Industry sector: Well-diversifi ed investors ensure that their money is spread over a number of different parts of the economy, such as health care, technology, manufacturing and so on. Why? When one industry is lagging, chances are good that another industry is steadily earning.

How do I make sure my portfolio is well diversifi ed?

Mutual funds and ETFs already have a certain amount of diversifi cation baked into them because they invest in a range of compan ies. In addition, these funds clearly lay out their investment strategies—including their diversifi cation priorities—in their prospectuses. Finally, each fund’s name usually includes a clue about their strategy. For instance, it might be called the Acme Emerging Markets Bond Fund or the Acme Small-Cap Stock Fund.

It can be tough to diversify your portfolio on your own. Some investors diversify too broadly, which can limit their ability to outperform the market. A Financial Advisor can help you optimize your portfolio to achieve the right level of diversifi cation as part of a strategy that is based on your risk tolerance, time horizon and individual goals.

Important Disclosures: [Financial Advisor Name] is a [Financial Advisor/Private Wealth Advisor] in [Branch Location] at Morgan Stanley Smith Barney LLC (“Morgan Stanley”). [He/she] can be reached by email at [fi rstname.lastname@morganstanley.com] or by telephone at [(212) 123-4567]. [His/Her] [California and/or Arkansas] Insurance License # is [license #]. [His/ Her] website is [Website Address – Optional].

This article has been prepared for informational purposes only. The information and data in the article has been obtained from sources outside of Morgan Stanley. Morgan Stanley makes no representations or guarantees as to the accuracy or completeness of the information or data from sources outside of Morgan Stanley. It does not provide individually tailored investment advice and has been prepared without regard to the individual fi nancial circumstances and objectives of persons who receive it. The strategies and/or investments discussed in this article may not be appropriate for all investors. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a Financial Advisor. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.

Diversifi cation and Asset Allocation do not assure a profi t or protect against loss in declining fi nancial markets. Value investing involves the risk that the market may not recognize that securities are undervalued and they may not appreciate as anticipated. A portfolio concentrated in a single market sector may present more risk than a portfolio broadly diversifi ed over several market sectors. International investing entails greater risk, as well as greater potential rewards compared to U.S. investing and may not be appropriate for all investors. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fl uctuations. These risks are magnifi ed in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economics.

Investors should carefully consider the investment objectives, risks, charges and expenses of a Mutual Fund and an Exchange Traded Fund (ETF) before investing. To obtain a prospectus, contact your Financial Advisor or visit the company’s website. The prospectus contains this and other information about the Mutual Fund or an Exchange Traded Fund (ETF). Read the prospectus carefully before investing.

Jan Paul C. Ferrer is a Financial Advisor in Chicago, IL at Morgan Stanley Smith Barney LLC (“Morgan Stanley”). He can be reached by email at janpaul. ferrer@morganstanley.com or by telephone at 312 312-419-3535

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