What Is A Diversified Portfolio In Investing?

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Key Takeaways:

• We define two key investing terms: asset allocation and diversification.  
• However, we don’t use a textbook. We illustrate how they can look on the ground.
• As such, an endless number of ways exist to maintain a diversified portfolio. 

To save yourself from some of the stress the thoughts and questions we started out with today can trigger, the answer begins and ends with diversification. However, we stress some, because no investment strategy eliminates every bit of anxiety. 

No matter how diversified your portfolio, it’s harrowing to see a stock – using NFLX as the example again – plummet $400 over the course of a year. 

Do you bail? If so, when? 

Do you stay the course and continue to add to your position, regardless of price? Because you think NFLX will retrace its steps. 

Do you write covered calls against your position to generate income to offset a fraction of the downside? (We’ll discuss covered calls later this month in The Juice). 

Here again, questions you can only wrestle with and answer for yourself.

Diversification And Asset Allocation 

This trusty chart from Fidelity defines asset allocation and illustrates its results. 

As you get closer to needing your money, you’ll move along the continuum from aggressive growth to conservative. Depending on your portfolio size, income, cost of living, and aversion to risk, you might never make your way all the way to conservative. But you see the point. 

If you’re 64 with plans to retire at 65, you sure as hell don’t want to go through a year with 60.78% downside in an aggressive portfolio, allocated heavily to stocks. 

Asset allocation defined and in action – what percentage of your portfolio do you allocate to each asset category on the basis of your specific situation? 

Some assets aren’t listed here. 

If you own real estate as income property, that counts. Because it can or will help facilitate your near- and long-term needs and wants. 

So What’s Diversification? 

Diversification can actually mean several things. 

• Do you spread your money effectively across assets? 
• Within assets, do you effectively spread your money around? 
• Within sectors (e.g., energy) or categories (e.g., large cap stocks), do you effectively spread money around? 

Effectively spreading your money around. A more precise definition of diversification. 

Because, let’s face it, you might be the type of investor who never invests in bonds, foreign stocks, or short-term instruments, such as certificates of deposit (CDs). 

You might begin and end with domestic stocks.  

If that’s you, going tech heavy – say owning all of the FAANG stocks – might have worked out well for you. Until it didn’t. 

Source: Google Finance 

For as ugly as the end of that chart is – particularly the last year – you’re actually sitting pretty if you put all your eggs in Facebook (META), Apple (AAPL), Amazon (AMZN), Netflix, and Google’s (GOOG) (GOOGL) basket five years ago. 

However, you’re sitting prettier if you also spread some of your money (effectively) across energy stocks. The upside we’re seeing there over the last year would have nicely made up for at least some of the recent downside in big tech. 

Along similar lines, you could have allocated a portion of your stock portfolio to financials, such as banks, and defensive consumer stocks like Procter & Gamble (PG). 

Many of these stocks, particularly the latter, pay dividends. This income generation can also help offset specific and broad downside. 

The Bottom Line: We broadened the definition of diversification.

In a perfect world, you’re always sitting on the proper allocation across investment types. However, the world ain’t perfect. If nothing else, the last few years proved this. 

In your closest conception of a perfect world, you put your money where it makes you feel most comfortable. That might be under your mattress. But, if you want to take on risk, spread that risk around. 

Most of us can’t time the market. Though we do know individual stocks, specific sectors, and other investment categories have good and bad days, months, and even years. 

If you expose yourself to a healthy assortment of stocks, sectors, and whatever else attracts you, chances are you’ll sleep better at night and see long-term investing success in the process.

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