Anytime you speak to a financial planner, they tell you you've got to diversify.
And you may be thinking, okay, I want to diversify, but what exactly does diversification mean?
The way I look at diversification is it's very similar to how you put together a meal.
When you are cooking dinner and you want to put a meal on the table, you want it to be balanced, nutritious and provide for your family’s health needs in an appetizing and pleasant way.
To do that, you draw on five food groups to create a balanced meal - vegetables, fruits, grains, protein, dairy.
Putting together a diversified portfolio is similar to putting together a good meal.
A diversified portfolio will draw from different aspects and parts of the market to make sure that it’s balanced. It’ll include a series or a collection of stocks and bonds that will provide for your financial needs.
Your financial needs, in turn, will depend on your age, your time horizon and your goals.
The very first decision that you need to make is how much of your money you want to put in stocks and how much of your money you want to put in bonds. That would be your carbs versus protein decision. And then as you go one level further you make another decision.
Well, if I want carbs, do I want rice or do I want pasta or do I want potatoes?
That would be a decision akin to whether you want to invest in large stocks, medium stocks or small stocks. And same with the bonds. Do I want a long-term bond or do I want a short term bond? That’s your protein decision - do you want chicken or fish?
And, oh by the way, what about broccoli? Broccoli is similar to the money market funds or CDs – boring but good for you.
I know this isn't sounding very serious, but that's typically what financial planners do to figure out portfolios for their investors. They need to decide, out of this vast choice of stocks and mutual funds and bonds and other investment vehicles, how to put together a portfolio for the clients to make their investments safe but also grow at the pace that the client needs for their goals.
Equally important, the portfolio has to be as risky or conservative as the client’s comfort level with risk will allow.
Just like a meal can nourish and uplift you, so can the well-constructed portfolio help you meet your goals. On the other hand, just as unhealthy diet can make you sick, a badly constructed portfolio will cause you to lose sleep, cause a lot of stress and you’ll run the risk of not meeting your life's goals.
If you want to build a diversified portfolio, you've got to understand what the different sectors and parts of the market are and how you draw from these different parts of the market to put together something cohesive, something healthy and balanced that will make sure that you're happy, healthy, and as financially secure as you can be.