To build a robust investment portfolio, it’s essential to diversify within various asset classes like stocks and bonds. If you concentrate all your investments in a single index fund, such as the S&P 500, a downturn in the broader market could negatively impact your entire portfolio. The key is to spread your investments across a wide range of stocks and bonds, which can help balance risk and returns.
It’s advisable to hold a minimum of 20 different individual stocks to prevent overexposure to any particular market segment. Also, you can invest in a selection of diversified index funds or mutual funds can provide exposure to hundreds of companies, further distributing risk. If you’re new to concepts like mutual funds and index funds, I recommend reading my previous blog on the subject.
With that being said, in this blog I’ll share the main types of stocks and bonds you can look into for a diversified investment portfolio.
Some common types of stocks you can own to diversify your stock portfolio:
Growth stocks- These stocks typically provide high returns because the company is on a growth trajectory. Think of innovative tech companies like a new AI or Crypto exchange company. These stocks are riskier than other types of stocks because if they don’t grow as anticipated, you likely bought the stock at an overvalued price that will lose money.
Blue chip stocks- These stocks are well-established company stocks with a proven track record of success. Think of stocks like Apple, Walmart, or Amazon. They were once growth stocks, but because of their great fundamentals over the years, their business model hasn’t changed in a long time. What they do works, and if you own a share you get to indulge in their earnings. The downside with blue chip stocks is that because they have been around for a while, it’s hard to buy them at a bargain to get great returns. Nonetheless, they are a safe investment in the long-run, and balance out the riskiness of owning a growth stock.
International stocks- These are shares in a foreign company. It’s important to own shares in a country besides the one you live in because it provides exposure to foreign markets. This can allow for decent returns when your residing country is in a recession. An example of a foreign company is Taiwan Semiconductor Manufacturing Company (TSMC) – this is just an example, not a recommendation!
Some common types of bonds you can own to diversify your bond portfolio:
Corporate bonds- Corporate bonds are bonds issued by companies f of their business. They borrow money from people and in return they pay them back with interest. Typically, the interest rate you would receive as payment from corporate bonds is higher than treasury bonds. This is because corporate bonds are inherently riskier, due to the fact that the corporation can default on their loan. This higher interest rate is attractive, but it’s important to also own treasury bonds to combat this risk.
Treasury bonds- Opposedly, treasury bonds always pay out, meaning they never default. That’s because treasury bonds are issued by the government. Because of this lack of risk, treasury bonds are an attractive bond to purchase. That being said, this high demand for treasury bonds allows the government to pay out lower interest rates to buyers. Choosing between treasury bonds and corportate bonds is deciding between higher reward and risk vs. lower reward and safety. To get the best of both worlds, own both!
Bond ETFs- You can also purchase a bond ETF. Bond ETFs are a collection of many different types of bonds (treasury, corporate, environmental initiatives, etc.). Owning a bond ETF is a great way to diversify your risk of a bond issuer defaulting on a loan.
Closing Thoughts
It’s important to diversify your portfolio such that it’s not over exposed to one market segment. To diversify your stock portfolio, you can own growth index funds, blue-chip (value) index funds, and international index funds. Don’t just take it from me. David Ramsay, finance guru, breaks down investment portfolio’s in a similar way. To check out how he discusses diverisifcation, check out his blog. You can also choose to opt out of index funds and look into individual stocks that diversify in a similar way.
I’ve noticed that my best investments have come from owning index funds, not so much from individual stocks. When you’re eyeing individual stocks, it’s key to do your homework and really understand the company you’re investing in. If you don’t fully understand the research, don’t count on any profits. Stay tuned for our next blog post where we’ll cover the essentials of how to do your own research on a company, setting you up to make informed choices.