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Denver Wealth Management Advisors Explain Diversification

February 28, 2018

Creating a sound investment portfolio is vital to establishing a long-term wealth management and growth strategy for your retirement. However, for many people just starting the wealth management and retirement planning journey, understanding how to structure their portfolio so it grows predictably without excessive amounts of risk can be truly challenging. While working with a fiduciary financial advisor will help you create a strategy for long-term growth, it’s vital that you understand why they make the recommendations they do. It all comes down to diversification and your Denver Wealth Management team explains the process.

What is Diversification?

Diversification is the process of managing your investment risk to help your savings grow over time. Though it seems similar to asset allocation, the two are dramatically different. Diversification does not focus on where you place your investments. Instead, it focuses on helping you create a balanced portfolio, allocating some of your assets to higher risk investments and others to low-risk and predictable return investments. This balance helps you achieve more stable and predictable growth over time without risking everything you have on a single platform.

Why Diversify When You Could Grow Rapidly?

Diversification does not ensure that your portfolio grows quickly, nor does it help boost the performance of your existing investments. However, it does protect your assets from being exposed to  intolerable risk levels. Risk is the chance you take on an investment—those with more predictable and nearly guaranteed returns are considered low-risk investments. Options with variable returns that can fluctuate with the market more volatilely are considered high-risk. One is not better than the other. In fact, both are needed in order to round out your portfolio.

It’s not unusual to want to grow your wealth quickly. After all, you have plans for every dollar you ear.  Though growing your assets should always be the end goal, investing solely in high-risk options can lead to devastating results. The saying that you should never put your eggs in one basket holds true for investments. Putting all of your assets toward potentially high returns is dangerous. If the market does not perform as you expect and the investments lose value, you’re out the money with little hope to recover your initial investment.

Caution and discretion are key in creating a successful wealth management plan. That said, no investor should ever place all of their assets in low-risk funds. These investments grow slowly and the amount of return you’d see at the end of the quarter or year would be minimal without the help of higher risk products. Slow growth is necessary for preserving your assets, but it’s not useful for growing them or setting you up for a successful and financially secure retirement. This is why reliable financial planners always recommend splitting your investments between both high and low risk options.

How Diversification Works

When you think of a diverse investment portfolio, you likely think of widespread investment interests. For example, a portfolio may include higher risk index funds, bonds, alternative investments like real estate or mineral investments. While this may appear diverse, it’s actually an example of asset allocation. A properly diverse portfolio will use asset allocation to gain the best returns possible without investing heavily in a single industry.

However, when you work with your financial advisor, they’ll want to diversify within each investment type. This means if you’re investing in a bond fund, they’ll allocate some of your assets to higher risk funds and others to low-risk funds. The same holds true for stocks, index funds, etc. This way, you can invest in the funds and products that you’re interested in while maintaining your ideal level of risk tolerance.

Determining Risk Tolerance to Aid in Diversification

During your initial consultation and periodically throughout the year, your financial advisor will want to discuss your goals and any changes to existing plans that may have come up. Ideally, you’ll want to save for retirement, but you may also be looking to establish a college fund for your children, set up a rainy day fund for home repairs or medical costs, or just increase your available income year after year. These things can change over time, and with them, your tolerance for investment risk.

Every single investment, no matter how seemingly stable it is, has risk. It’s part of the process and, given the market’s inherently changeable nature, it cannot be avoided. For most investors, the younger you are, the higher your risk tolerance is. This is because if you suffer a loss on an investment, you’ll have more years before retirement to fully recover from that loss. As you grow older and more predictable returns are favored, your risk tolerance declines. The better you understand your risk tolerance, the better prepared your portfolio will be to see the growth you’re looking for.

Diversification is a Continual Process

Since your risk tolerance changes almost yearly, it’s important to reexamine your portfolio’s diversification frequently. Your advisor will work with you to establish your current risk tolerance and adjust your investments as needed to match the current level. Some years, you may be able to tolerate higher risks than others and your investments can change accordingly. This is part of the wealth management process and if anyone suggests that your diversification should be stagnant, seek a different opinion. Your diversification should change to help you achieve your goals quickly and successfully.

Putting together a truly diverse portfolio with your interests in mind takes experience, understanding, and a willingness to get to know you and understand your goals. Why take the chance on a nameless investment firm when you can work with an experienced fiduciary and financial planning expert at Foxstone Financial? Our dedicated team will work to help you reach your goals, whether you’re saving for a child’s college fund or wanting to maintain your standard of living well into retirement. Contact us today to schedule a consultation and see the difference that experience and passion can make in helping you plan for the future.