Understanding the Factors Behind Diversifying Your Portfolio

Sun, Jul 07, 2019 at 2:10PM

Kevin Smith, President, KMS Wealth Management, Inc.

One of the proven ways to reach your long-term financial goals is through an investment technique known as diversification. Diversification basically means spreading out your invested money across different investment types, industries, countries, etc., which can smooth out the performance of your portfolio and may lead to stronger returns over the long term. Helping you take advantage of the benefits of diversification is a central part of your advisor's job.

One of the guiding factors behind diversification is that not all investment categories perform well at the same time; as some are increasing in value, others may be decreasing. The movement up and down of investment categories is referred to as market volatility.

Maintaining a Well-Balanced Portfolio

Your advisor should help you maximize returns and reduce the risks associated with market volatility by creating a portfolio that effectively diversifies your investments. Essentially, your portfolio represents a collection of different
investments that work in harmony to help you reach your goals. One way you can achieve portfolio diversification is to divide your investments among the major asset classes, namely equities, fixed income and cash.

Asset Classes - A Range of Risks and Rewards

Each asset class comes with varying degrees of risk and return characteristics and typically performs differently in
certain market environments. Here's a quick summary of each:

■ Equities (e.g., stocks) refer to buying stocks or shares of a business, making you a part owner. This means you are entitled to profits when stock values increase but are also subject to the risks of declining stock value if companies underperform.

■ Fixed income (e.g., bonds, Treasury bills) investors lend capital in exchange for interest. Considered creditors, bondholders often have a priority claim in case of company bankruptcy or default, making the investments less risky. Fixed income assets typically provide income at regular intervals.

■ Cash (e.g., money market funds, bank accounts) investments provide low returns versus other asset classes, in the form of interest payments. These investments typically come with very low levels of risk.

Investment Funds - One-Stop Diversification

An advisor can also help achieve diversification through the use of investment funds; namely, mutual funds and exchange-traded funds (ETFs). These investment vehicles represent convenient and affordable ways to access a wide range of investments.

■ Mutual funds are made up of a pool of assets from many investors and managed by a portfolio manager who actively seeks to produce greater returns than a specific market benchmark, such as the S&P 500 Index. With the large scale of a mutual fund, you benefit from professional management and can get strong diversification by gaining access to investments that would normally be inaccessible or too expensive for most individuals.

■ ETFs track and seek to replicate the performance of select market indexes. Because ETFs represent a basket of securities based on the underlying index, you can gain broad diversification across entire markets, industries, regions or asset classes. ETFs are known to incur fewer administrative costs (and therefore charge lower fees to investors) since they're simply tracking an index without trying to outperform it.

FRM

Kevin Smith is President of KMS Wealth Management, Inc. and has partnered with FRSA to offer members a retirement option through TAG Retirement Program. More information about this program can be found on FRSA's website, www.floridaroof.com under the Member's Login section. If you have additional questions, please contact Kevin directly at 407-923-8724 or by email at kevin@kmswm.com or visit www.kmswm.com.


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