When you diversify, you allocate your money to different assets: stocks, bonds, cash, and maybe a fourth pile, like real estate. Divvying up your money protects you against significant losses in any one area by spreading your assets around. It provides a buffer against risks like inflation and severe market fluctuations.
Diversification seems simple—but emotions can get in the way. You might decide you need 60% of your portfolio in stocks, 35% in bonds, and 5% in cash to accomplish your goals and balance your risk. At the end of a quarter, let’s say stocks did really well—as a result, your stock allocation increased to 65%, while your allocation to bonds dropped to 30% and cash held steady at 5%.
If you react based on emotion, you might be tempted to leave the portfolio alone, reasoning that it doesn’t make sense to reallocate money from a strong area to a weak one.
But market cycles are inevitable—and next quarter, stocks might go down while bonds go up.
Committing to diversification means pushing back against your emotions and sticking with your plan to protect your portfolio and manage risk.
Protect yourself. How do you keep your portfolio in check?
|Carl Richards, aka “the napkin guy”, and father to three daughters and one son, is renowned for his weekly sketches on the NY Times Bucks Blog and is now a DailyWorth contributor.|