The old adage is true: money doesn’t grow on trees. With that said, there’s an apt comparison between investing and farming that highlights a necessary ingredient for long-term success: diversification. A farmer that plants only a single type of seed exposes themselves to risk. Bad weather could destroy an orchard full of the same tree, or a certain type of beetle might plunder an entire crop.
Investments follow the same logic. Global market forces and the domestic economy all represent unknowns, like pests or precipitation for the farmer. A diverse investment portfolio includes more than a single type of investment. Taken together, the returns promise wealth over time.
Unlike short-term gains in the market, a strategy for generational wealth includes long-term investments that pay dividends years, or even decades later. No matter your risk tolerance or experience with investing, knowing how to diversify your investment portfolio will enhance your long-term wealth.
Why Balance Matters
Diversity is the best way to protect yourself against risk. Not only should your portfolio include different types of investments (stocks/bonds, cash, non-traditional investments), but there should be a combination of high- and low-risk investments.
High-risk investments usually pay the best dividends in the short term, while low-risk investments can take years to mature. The low-risk investments can help balance your portfolio’s net worth even when high-risk investments perform poorly.
Similarly, investing in different asset classes (traditional investments as well as real estate, commodities, or insurance policies) protects your wealth from global market volatility.
Choose a Blend of Stocks and Bonds
Stocks typically offer high returns with greater risk, as opposed to bonds, which are safer but pay a lower dividend. Younger people might have more of an appetite for risk, as they are able to more easily recuperate loss. Those in their retirement years, on the other hand, often prefer to minimize risk and safeguard their portfolio’s health.
Forbes recommends subtracting your age from 100 to deduce the percentage of stocks you should consider for your portfolio. For example, a 35-year-old might have 65% stocks in their portfolio, with 35% bonds or other long-term securities.
Diversify Cash Holdings
A high-yield savings account can offer an even better return than a bond for those who would rather park their wealth outside of financial markets. Money that stays in a savings account earns compound interest — something Einstein referred to as the “eighth wonder of the world” for its ability to grow wealth exponentially — and is protected by FDIC insurance schemes.
Investing in different currencies is another form of diversification. While stocks rise and fall independently, currencies change value in relation to one another. Investing in the Euro or Yen will protect your wealth against any future decline in the dollar, particularly for investors whose portfolio is full of US-based equities.
Consider Non-Traditional Investments
Besides the traditional investment types — stocks, bonds, and cash — non-traditional investments can help diversify your portfolio as these investments behave differently over time. Adding non-traditional assets can protect against market volatility and enhance overall returns.
Investing in real estate has the potential to offer steady passive income returns, long-term security, and certain tax incentives. Real estate values can skyrocket over the course of a few years, but there is nonetheless a risk associated with this type of non-traditional investment.
Investing in residential or commercial properties or house-flipping represents more risky investments that demand a substantial amount of time and market awareness. Real estate investment trusts (REITs) offer a lower bar to entry, allowing investors to purchase a share of the profits from a pool of managed properties — something like a mutual fund in traditional investment markets.
For as long as humans have assigned value to objects, precious metals (and stones, going back further) have ranked among the top commodities. Investing in gold and other precious metals can help safeguard your portfolio’s value from inflationary risk and unfavorable market conditions.
The crypto vs. gold debate can be compared to day trading vs. investing. Cryptocurrencies offer a high return with a high risk but aren’t guaranteed to maintain their value over time. Gold and precious metals, on the other hand, have implicit value because their material properties are useful in a number of applications — from jewelry to machinery and electronic components.
An individual retirement account (IRA) is a retirement savings account that offers tax breaks and other long-term advantages for those planning long-term investments. The main types of IRAs include traditional and Roth IRA. The main differences between the two have to do with how money is taxed before it’s put in the account, when it grows, and when it is withdrawn from the account.
Unlike the two primary IRA types, a self-directed IRA allows individuals to take charge of the types of investments in their IRA portfolio. Aside from the riskiest investments, almost all other types of investments are available for IRA owners to explore within their self-directed IRA, affording them a wealth of opportunities to diversify their investment portfolio.
Don’t Put All Your Eggs in a Few Baskets
The more diverse your portfolio, the more it is able to absorb shocks from sudden changes in the market. A healthy balance of high- and low-risk investments ensures a healthy return while offering a hedge against risk.
Diversifying the types of assets and investment areas adds an additional layer of protection, ensuring the greatest potential for return even in the face of global market shocks or industry volatility.