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| Tips for Getting Diversified |
Here are some steps to follow when building a diversified retirement account.
- Invest in more than one asset type (allocation). You shouldn't limit your investments to just one asset class. In fact, most investors hold a diversified portfolio comprised of stocks, bonds, and cash (such as Treasury bills, money-market accounts, and short-term CDs). A diversified portfolio has two major advantages. First, you can tailor your investment choices to the level of risk appropriate for your goals, time horizon, and risk tolerance level (in general, bonds are less risky than stocks and cash is the safest). Second, by including all three of these asset types in your portfolio, you take advantage of the fact that they are not perfectly correlated—that is, each type should perform well (or poorly) at different times, so that at any given time one will be up while another is down. This reduces your portfolio's overall risk and helps contribute to performance.
- Buy different varieties of the same security type (style diversification). Within stocks, bonds, and cash, you can find plenty of variety in terms of risk level and return. Stock investors can get exposure to both the slow and steady performance of blue-chip stocks and the exciting growth possibilities of small-cap stocks. Investors who buy fixed-income instruments can diversify by choosing bonds with different maturity dates and interest rates, such as T-Bills and Treasury bonds. They can also invest in bonds with different credit ratings, which measure the likelihood of that the issuer can repay its debts. Usually, the lower the bond's rating, the greater the risk and the higher the interest rate it pays in order to compensate you for assuming the greater risk.
- Invest in different industries (sector and country diversification). One way to reduce risk is to buy stocks that aren't too closely related or correlated. Say, for example, you invested in five chemical companies. You wouldn't be diversified, because these stocks would probably move in the same cyclical patterns. But if you invested in a commodity chemical producer, a retail store chain, a media company, a software producer, and a maker of breakfast cereals, you could reasonably expect that part of your portfolio would be doing well even when the others weren't. This is also true for investing in stocks from other countries. One country's economy may be doing better than other's.
- Invest in mutual funds. If you invest in funds, much of the work of diversification will be done for you. Most mutual funds usually are highly diversified investment , and even if you only invest in one fund you will still be more diversified than you could be if you bought individual stocks on your own.
- Diversify among different types of mutual funds. There is a mutual fund for every conceivable investment style. You can find out from the prospectus what types of securities a fund invests in. The names of some funds—small cap, growth and income, large cap, international, etc.—can help indicate what they buy and sell. Don't limit yourself to just one.
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