What is a Diversification? What Tips Do You Offer Your Client to Ensure Their Portfolio is Diverse?
Diversification is the act of investing in a variety of different areas in order to reduce the overall risk of your portfolio. Essentially, it takes the age old saying of "Don't put all of your eggs into one basket," and applies that to the world of finance. When looking at your portfolio, there are three main layers to check for when it comes to diversification.
The first layer of diversification to consider is investment philosophy. Currently the two dominant investment philosophies are Passive Management (ETFs and Index Funds) and Active Management (Mutual Funds). The most diversified portfolios utilize a combination of Passive Management and Active Management. This is an important layer of diversification because in some years Passive Management does best, while other years Active Management does best.
The second layer of diversification to consider is investment company. There are many different companies you can "hire" to manage the individual investments within your portfolio each with their own unique style and track record. The most diversified portfolios utilize several investment companies rather than sticking to just one. This is an important layer of diversification because it limits your exposure the biases and unique tendencies of each individual company.
The third layer of diversification to consider is asset allocation. Your portfolio's asset allocation is the mix of asset classes you are invested in. Examples of asset classes are domestic stocks, international stocks, bonds, international bonds, large cap stocks, mid cap stocks, and small cap stocks. While your specific asset allocation depends on your risk tolerance, time horizon, and goals, the most diversified portfolios utilize several different asset classes.
There may be additional layers of diversification to consider, such as tax diversification, sector diversification, and region diversification. However, the most impactful layers of diversification to check for when reviewing your portfolio are; investment philosophy, investment company and asset allocation.
Cetera Investors is a marketing name of Cetera Investment Services. Securities and Insurance Products are offered through Cetera Investment Services LLC (doing insurance business in CA as CFG STC Insurance Agency LLC), member FINRA/SIPC. Advisory services are offered through Cetera Investment Adviser LLC. (CA Insurance License #: 0I34349)
Asset allocation, which is driven by complex mathematical models, should not be confused with the much simpler concept of diversification.
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Cetera Financial Group (Cetera) is a leading financial advice firm. It empowers the delivery of an Advice-Centric Experience® to individuals, families and businesses across the country through independent financial advisors as well as trusted tax professionals and banks and credit unions. It’s headquartered at 200 N. Pacific Coast Highway, Suite 1200 El Segundo, CA 90245-5670.
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Individuals affiliated with Cetera firms are either Registered Representatives who offer only brokerage services and receive transaction-based compensation (commissions), Investment Adviser Representatives who offer only investment advisory services and receive fees based on assets, or both Registered Representatives and Investment Adviser Representatives, who can offer both types of services.
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