Financial Diversification is a strategy that was designed to reduce the risk of combining a variety of investments within a portfolio. The main purpose for this risk management strategy is to reduce exposure to financial risk by mixing a variety of investments which are unlikely to all shift in the same direction. These investments are often refer to as bonds, stocks, and mutual funds but other types will be address as well.
This process is an attempt to balance out the performance of all investments in a portfolio, so that the positive performance of some of the investments will neutralize the negative performance of others. This method will, more likely, only work as long as the securities in the portfolio are not perfectly interrelated. Unlike hedging, diversification relies on the lack of a positive relationship among the assets’ returns.
It is important that the type of investment options that fall under diversification are addressed.
Most financial advisors and financial traders often acknowledge and emphasize bonds, savings, annuities, stocks, insurance and mutual funds as the type of investments an individual needs in order to diversify their portfolio. However, mutual funds, bonds and stocks are all paper assets. This fact cause to raise questions such as:
- What would happen if the stock market tanked and all my investments are based on paper assets?
- What other choices are there?
Back in 2007 the stock market suffered an unexpected downturn and dropped significantly creating a global financial crisis. At that moment all paper assets took a hit and tanked along with the financial market. This situation greatly affected investors whose portfolio exclusively comprised of paper asset investments.
Smart investors research their options beyond what their financial planner offers. A financial planner will always provide counsel and lead clients towards the options they are familiar with. It is up to the individual to understand that every expert in a subject matter may not necessarily know all the key components outside their five sense range. An advisor whose expertise lies in paper assets often is not able to provide guidance in anything outside a diversification of paper assets and stocks, limiting clients’ exposure to one-fourth of the financial diversification options. Indirectly, this is also keeping clients from experiencing a higher success rate and an increase in profits.
The Four Diversification Choices Available are:
- Owning a business – this can provide the passive income needed to fund the rest of the investment options available in a diversification plan.
- Paper assets – such as stocks, bonds, insurance, annuities and savings.
- Commodities such as gold, silver, oil, platinum, etc. These have become very popular among wealthy individuals. Investing in these commodities have been highly recommended by rounded individuals such as Robert Kiyosaki. It is advised that, once the decision is made, knowledge is seek out.
- Last but not least, income producing investment real estate – these are assets that produce a monthly passive income and increase your total wealth.
Financial Diversification is a lot more than investing 401K funds in the stock market. It is more than investing in a mutual fund, small or large cap stocks, precious metal stocks, exchange trade funds, money market or real estate investment trust fund. It is understanding the options available outside what the regular financial planner or insurance broker can offer and making an informed investment decision based on well rounded and factual data.