If you walked into my shoe closet, you will notice two things: I have a large collection and many different options. I’m sure if you are like me, you have sneakers for working out or running errands, sandals for those sweltering summer days, flats for chic-meets-comfortable style, boots for that unexpected Snowpocalypse and heels — stilettos, of course — for the all-too important business meeting, social event of the year or hot date with a significant other. Most women wouldn’t dare go jogging in their Jimmy Choos or attend an important client meeting in their Chuck Taylors (but no judgment if you do!) That’s where diversification comes in, and it makes all the difference in a woman’s wardrobe. The same can be said about your investments and finances.
Take, for instance, asset allocation, which involves arranging your financial portfolio in such a way so it is made up of a variety of investments that may include stocks, bonds and cash. The allocation of your financial assets is a personal decision and relies on individual factors such as long-term vs. short-term financial goals and your ideal level of risk tolerance. Much like owning an array of shoes that have you covered for any occasion, investing in a mix of stocks, bonds and cash can be a solid strategy for achieving financial security and success.
In essence, stocks are like the sexy stilettos of finance — they can be risky and painful at first but often result in a reward of strong positive returns over time. Bonds are more like your trusty pair of comfortable-but-stylish flats, less unpredictable than stocks with modest returns. Cash is akin to your traditional sneaker — safe, dependable and low-risk.
Once you’ve determined your asset allocation, it’s time to diversify. You probably wouldn’t pair brown loafers with your favorite little black dress, because if you are like me, you feel it just doesn’t go together. The same can be said of some investments when compared to your risk tolerance. That is why it’s imperative to have financial options. Diversification involves spreading your money among various investments; in case one investment goes kaput, the other investments will more than make up for the loss. A diverse financial portfolio occurs at two levels — between asset categories (the stocks, bonds and cash we discussed above) and within various segments of those asset categories such as industry types, market capitalization, security rating, tax status or position within its growth cycle. The latter can be achieved by identifying and investing in an array of at least a dozen company and industry sectors (i.e. industrials, commodities, technology, energy, consumer staples, consumer discretionary, health care, automotive and financial), or via a variety of exchange-traded funds (ETFs) or mutual funds. Consider the timeless old adage, “Don’t put all your eggs in one basket.” The same can be said for your shoes and your financial investments!
In turn, as you grow closer to meeting your financial goals, it remains crucial that you consider altering your asset allocation and re-diversifying. In much the same way one needs to habitually clean out their shoe closet, it is important to rebalance your financial portfolio on a consistent basis.