It is important to recognize the amount of risk you're willing to take on in order to achieve a diversified portfolio. On this episode, Casey Smith, Matthews Barnett, CFP®, ChFC®, CLU® and Brad Lyons, CFP® talk about the importance of portfolio diversification. They talk about modern portfolio theory, the efficient frontier line, allocating your assets, and they offer advice on how to diversify your portfolio.
- Click here to download one of our free guides that covers financial planning topics like retirement, investing, taxes, divorce, and more!
Connect With Wiser Wealth:
- Our Website
- Schedule a Free Consultation (Learn More About Wiser)
- YouTube
- Facebook
- LinkedIn
- Instagram
- Twitter
- Podcast
- Blog
This podcast was produced by Wiser Wealth Management. Thanks for listening!
Modern Portfolio Theory
Modern portfolio theory is a useful tool you can use when diversifying your portfolio. It has become widely accepted in the investment community and is now one of the basic principles of investment management. An important thing to keep in mind is it’s all about optimizing your portfolio to where you can achieve your return goal without taking on more risk than is needed.
Choosing Investments to Optimize Your Portfolio
To begin choosing investments that are right for your portfolio, start by listing your options. After choosing asset classes, visit ETF.com to look for the expected rate of return and volatility to see which ones best suit your portfolio. Go through the list you have come up with and allocate funds to each one. When allocating your funds, be sure to choose non-correlated investment opportunities. For example, if you are invested in a correlated stream such as large cap and small cap, also invest in non-correlated streams like real estate. It is important to have both because it can help to diversify your portfolio.
Efficient Frontier Line
As an investor, it is important to measure the amount of risk you need to take on to reach your expected rate of return. The efficient frontier line can help you do this. The efficient frontier line is an upwardly sloping curve on a chart that demonstrates levels of risk and return for an investment. Keep in mind, anything under the line means you’re taking on too much risk and not getting enough return. By looking at the efficient frontier line, you can utilize expected return ratios and standard deviations for risk to create a portfolio that’s as close to that line as possible.
Diversify Your Portfolio
Start with picking the correct fixed income for your unique portfolio. This can be tricky because there are so many kinds of fixed income, each with its relevancy to a portfolio. If you blend fixed income with stocks, you can raise or lower the amount of risk and return you’re taking on. Bonds should also be incorporated to stabilize the stocks. Be sure to avoid high yield and emerging market bonds because they won’t diversify your portfolio. Manage your risk and allocate percentages based on how big your portfolio is. Remember, the larger the portfolio the larger the percentage you’re risking.
Asset Allocations
To manage your risk and return, maintain your allocations. There are a few different tools you can use to allocate your assets. Vanguard, BlackRock, and State Street have model templates for public use. These templates can help you build your portfolio. You will begin to see if your portfolio is diversified well enough, you’ll have some of your money in the best performing asset classes. Now, if the stock market is in a downturn, weather the storm and don’t move asset classes in the middle of a crisis. Instead, it is important to do it either in a normal market setting or at a market high.
Beware of Mutual Fund Managers
Fund managers have free reign, so most of the time they throw in riskier investments when they are not needed. They are also inconsistent because they quite often change the way they invest. Instead of using mutual funds right away, a great tool to use is Morningstar. Start with putting your portfolio in, run an x-ray report, and learn where your assets are by asset class. For a DIY investor it’s not always easy but having a strategy can help you reach your long-term goals. Take into consideration the more diversification you have within your portfolio, the higher chance you have of success.