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Why Is Portfolio Diversification Important for Investors?

, | December 28, 2022 | By

No matter what your long-term financial goals are, making smart investments along the way can be a major factor in your success. Portfolio diversification is a highly recommended investment strategy that you should consider if you’re serious about investing.

 

What is portfolio diversification?

Portfolio diversification is essentially the act of choosing different types of investments that don’t have the same historical performance. To do this, people typically invest in different types of assets, such as:

  • Stocks, bonds, and mutual funds
  • Real estate
  • Private notes 
  • Businesses
  • Cash
  • Hard assets, such as precious metals, art, and watches

Strategic asset allocation allows you to build a portfolio that is more resilient than one made up of just one asset class. Even when one asset is in decline, a balanced portfolio has a better chance of generating overall returns. 

It’s also important to think about the liquidity of your investments. For example, private loans are safe, relatively liquid, and stable investments with decent yields, whereas the liquidity and value of hard assets depend on their value at any given moment.

 

What happens when you don’t diversify?

Markets of all types fluctuate but not always in the same way. Having different types of assets can help protect you when one market swings. When you don’t diversify, you have all of your proverbial eggs in one basket. Although many markets go through cycles, and you may be able to wait out a down period, the possibility of losing your investment is always a reality, especially if all of your investments are in the same asset class.

 

What are the benefits of diversification for your investment portfolio?

By diversifying your portfolio to include a mix of assets such as private notes, stocks, and real estate, you get the potential benefits of managing risk and stabilizing returns.

 

Manage risk.

Portfolio diversification allows you to choose a variety of investments that match your risk tolerance. When you have investments in multiple types of assets, you maintain the possibility of generating returns, even when one or more markets are in decline. Having a combination of high-risk assets, such as cryptocurrency, balanced with assets such as private loans, which typically deliver more stabilized returns, allows you to balance risk.

 

Stabilize returns.

Putting all of your investments into high-risk assets such as cryptocurrency or trading options can give you the largest gains; however, there are no guarantees. A diverse portfolio may have the potential to perform better than if you were investing in just one asset class, especially in the long term. You can also choose assets that tend to have more predictable returns. For example, because private loans generate income from the interest on the loans, the returns tend to be more stable.

 

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How do you successfully diversify your portfolio?

When strategizing, it’s important to keep a few things in mind. Investing is a dynamic activity, and you can’t just set your diversification strategy and forget it. Follow these tips when diversifying your portfolio. 

 

Choose the right asset mix for your risk tolerance.

Different types of asset classes come with different levels of risk. Understand the nuances of each type of asset you’re considering and how much of your portfolio they should account for.

 

Do an annual checkup.

Investing preferences change over time. You might be more or less risk-tolerant than you were when you made your initial investments. Your financial situation might also change with a new salary or a windfall. Take a look at your portfolio at least once a year to determine if your asset mix stills feel right for your goals. Make adjustments as needed and repeat the process on a regular basis.

 

Stay diversified within each asset type.

If you invest in the stock market, diversify with a mix of stocks and bonds with different market capitalizations. With your real estate investments, maintain a mix of residential and commercial properties. You can also diversify geographically to protect yourself against local fluctuations. The more diversity you have, the more potential you have to manage risk.

 

Invest in private notes with Socotra Capital.

If you want your portfolio to include a safe, relatively liquid, and stable investment with decent yields, consider investing in private notes. When you invest with Socotra Capital, you can be confident that our team uses a successful underwriting process that has historically yielded predictable returns. 

Because you’re investing in a fund that provides real estate loans across multiple types of properties, you’re also maintaining diversity within this asset class. You earn money on the interest from the loans, but you don’t have to do the work to find borrowers, vet them, and collect payments. Visit the investor portal to learn more. 

If you’re interested in generating income with minimal effort, check out our free guide, How to Grow a Passive Income Portfolio in Today’s Market.

 

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