Diversifying is a big part of lowering risk. Although, risk can never be lowered to zero percent. Things come up, life gives you lemons. If you need to pull from your IRA early, a 72t rollover is probably your best bet. You’ll save 10% on your early withdrawal penalty by following the procedure and withdrawing your money following a certain formula.
Today, our world as a whole faces more economic turmoil than arguably any other time in history. Investing is still necessary to make the most out of our financial assets. But, the market conditions do require a more educated investor. You also need to make sure that you are taking every step to protect yourself. To this end, we want to explain why it’s important to diversity your assets.
What is Diversification?
We will start by explaining exactly what is meant by diversification. This is a technique that reduces the overall risk of the individual investor. You reduce this risk by making sure that your assets are spread across a mix of investment opportunities. They are usually spread across different financial categories, industries, and/or financial instruments.
The goal is to maximize the potential return from any market event. You assets are spread into areas that will react differently to any change in the market. For example, if your portfolio includes gold, silver, real estate, technology stocks, and stocks in fortune 500 companies then it will react differently to market changes.
For instance, if the price of gold does down at the same time that technology stock go up then you are more likely to still obtain a positive return. If you had all of your investment in gold then you miss the other opportunities that happen at the same time that the price of gold goes down.
Types of Investment Risk
When you are investing your money, there are two different types of risk; undiversifiable and diversifiable.
Undiversifiable risk is also referred to as market risk. These are changes that happen within any company that you have no control over. They are things like inflation, rate of exchange, politics, changes in the interest rate, and even war.
Diversifiable risk are changes that happen with an industry or area of investment. This is also referred to as unsystematic risk. You do have some level of control over these factors by using diversification. These are factors like business and financial risk. Diversification allows you to spread your assets over different investment areas so that you also spread out your risk.
We touched on how diversification allows you to spread out your risk. This is a great reason to diversify but is not the only reason. There are a multitude of benefits that you receive by implementing this strategy. We provided one example but we want to give you another.
Let’s look at stocks in an airline company per say. If there is an announcement that their pilots are going on strike then this is going to negatively affect their stock price. If you are only invested in the stocks of this one company then all of your investments will be affected. But, if you are also invested in railway stocks then your portfolio as a whole does not go down.
Investment is an important part of overall financial health. But, to get the most out of your investments you need to use a long term approach. You also need to protect your portfolio against loss. This is why it’s important to diversify your assets.