One thing that the recent financial crisis has taught us is that very few investments are completely safe. Unless you invest in certificates of deposit or treasury bonds, every asset in your portfolio has some risk associated with it. On the other hand, without taking risks it’s often hard to generate significant growth – for example, if you buy CDs you’re unlikely to make much more than 1% per year unless you lock your money in for 20 years or more.
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The secret to building a successful portfolio is to create a balance of risks and rewards that suits your investing style and your time of life. For instance, if you are in your 30s then you may be more open to risks, whereas as you approach retirement the most important thing is to protect the existing value of your portfolio and start to generate retirement income.
One of the best ways of striking this balance is to make sure that your portfolio is diversified. This is what any successful investment professional – such as Scott Reiman Hexagon Investments President – will tell you. Diversify across asset classes, such as stocks, bonds, commodities and real estate. And diversify across geographies, funds and managers. Of course, you can weight your investments depending on your risk profile.
Another key diversification strategy is to own a wide spread of assets, even within a single asset class such as stocks. First, make sure that you have a position across a number of industries, since when one industry is having difficulties, the chances are another one will be booming. Also make sure that you have a mix of medium and low risk stocks – while you are not going to get the same return on Ford, for example, that you might get on Tesla Motors, you are also much less likely to lose your entire investment. By creating this type of mix, you lower your overall risk while still creating opportunities to make big wins.
In fact, it is a good idea to build some automatic diversification into your portfolio by investing in index funds. These are funds that track the overall performance of specific market indices – for example, the S&P 500. Aside from providing diversification, the other advantage of this type of investment is that the management fees are generally quite low. Unlike a mutual fund, where the fund manager actively makes investment decisions, index funds follow a much more mechanical process and therefore do not warrant a premium for management fees.
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Finally, there is nothing wrong with having high-risk/high-reward assets in your portfolio, but they should be moderated with safer investments. Think of these as if they were lottery tickets – if you win, then the rewards are spectacular, but you wouldn’t spend the rent money on them. Of course, these types of investments are more likely to pay off than lottery tickets – particularly if you do your research well – but you have to be prepared to lose your money.