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Managing Risk With Diversification

By Kirtland Financial Services

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When you first considered investing, it probably seemed like a good idea to focus heavily on what worked best for you from the beginning. If stocks from a particular company brought you high yields, why not double up on your original investment? The answer is diversification. It may seem counterintuitive, but diversification is a fundamental aspect of risk management, and plays a critical role in building an investment portfolio.

Effective diversification requires more than just purchasing a random bundle of investments. Otherwise, your investment may all move in the same direction in both up and down markets. Instead, investors might want to consider selecting securities that do not all move in correlation to each other. The U.S. Securities and Exchange Commission advises investors to diversify1 by asset category and within the asset category.

Diversify by Asset Categories

Asset allocation is the practice of dividing up your investment capital among different asset categories. This covers three main asset classes: stocks, bonds and cash. Some financial advisors consider this separate from diversification. Even so, the fundamental principle is the same and can be used in tandem with company-specific or industry-specific diversification.

While asset allocation may help to manage market risk, it does not provide a guarantee against market losses. It seeks to provide a cushion against market volatility2.

Diversify Within Asset Categories

When it comes to diversifying within asset categories, financial advisors focus on spreading out stock among different types of companies. There are also different types of bonds to consider.

Yes, the portfolio may, at times, yield lower returns than those from investors who decide to specialize.

Putting These Concepts to Work

So, what steps can you follow to manage risk, especially as you draw closer to retirement? Here are a few tips to consider:

  1. Choose Investment Style: Investment styles further affect how you diversify your portfolios, so be sure to find one that works for you. Some of the most common options include small-cap versus large-cap, sector vs. industry, growth vs. value and domestic vs. foreign. 
  2. Determine Asset Allocation: Deciding how much of your capital to invest in each category depends on a number of factors, such as your personal ability to tolerate risk and how soon you may need to liquidate investments. As an example, younger people may want more risk exposure, while people closer to retirement may want to err on the side of caution.

Overall, your general appetite for risk determines how best to diversify your investments. Contact Kirtland Financial Services for more information on how to strike the right portfolio balance.

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There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

This material was prepared by LPL Financial, LLC.

Sources:

  1. https://www.investor.gov/additional-resources/general-resources/publications-research/info-sheets/beginners-guide-asset
  2. https://www.forbes.com/sites/wadepfau/2016/11/03/how-does-diversification-actually-work/#4b34efd37a4d
  3. https://www.bankrate.com/investing/diversification-is-important-in-investing/

Securities and advisory services are offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC). Insurance products are offered through LPL or its licensed affiliates. Kirtland Federal Credit Union and Kirtland Financial Services are not registered as a broker-dealer or investment advisor. Registered representatives of LPL offer products and services using Kirtland Financial Services, and may also be employees of Kirtland Federal Credit Union. These products and services are being offered through LPL or its affiliates, which are separate entities from, and not affiliates of, Kirtland Federal Credit Union or Kirtland Financial Services. Securities and insurances offered through LPL or its affiliates are:

Not NCUA Insured or Any Other Government  | No Credit Union Guaranteed | Not Credit Union Deposits or Obligations | May Lose Value

The LPL Financial registered representatives associated with this website may discuss and/or transact business only with residents of the states in which they are properly registered or licensed. No offers may be made or accepted from any resident of any other state.

Kirtland Federal Credit Union (“Financial Institution”) provides referrals to financial professionals of LPL Financial LLC (“LPL”) pursuant to an agreement that allows LPL to pay the Financial Institution for these referrals. This creates an incentive for the Financial Institution to make these referrals, resulting in a conflict of interest. The Financial Institution is not a current client of LPL for advisory services.

Please visit https://www.lpl.com/disclosures/is-lpl-relationship-disclosure.html for more detailed information.

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