How to Add More Diversity (without Complexity) to Your Portfolio


by

16 June,2014

If you want to make the most of your money over a longer period of time, one of the best things you can do is invest. The power of compound interest can provide you with a way to grow your wealth when you practice consistency in your investing. However, trying to put together the right portfolio for your needs can be a daunting task.

One of the concerns that many people have when investing is with diversity. You know that you are supposed to have appropriate diversity in your portfolio, but there are some who wish that they had more to choose from than stocks and bonds.

Why Diversity is Important

Diversity is one of the building blocks of smart investing because it allows you to spread your risk. The idea behind diversifying investments is to use different asset classes in your portfolio so that you aren’t negatively impacted too greatly when one asset class falters.

The principle of diversification also applies when you are choosing investments across sectors and industries. If services companies are doing poorly, there might be some technology stocks that are doing well. With a little diversity in your portfolio, you can protect against some of your losses. It’s a way of making sure that all of your eggs aren’t in one basket.

Even though most experts agree that a mix of stocks and bonds (keep it simple with help from low-cost index funds and ETFs) allows for sufficient diversity, many investors still wish they had a little more variety in their portfolios. For some investors, stocks and bonds, which can sometimes be rather correlated in their performances, aren’t enough. It’s tempting to look for other assets to add to the portfolio in order to give it more breadth.

However, it can be intimidating to choose other investments for a portfolio. The good news is that it doesn’t have to be complex. There are some relatively simple ways to diversify your portfolio further.

Real Estate Investment Trusts (REITs)

There are many people who want to add real estate to their portfolios, but they don’t have the desire or the capital to buy property. Real estate is a great asset to use for diversification because it doesn’t always move with stocks or bonds (although you do have to watch out for bubbles and down markets, just as you do with any other investment asset class).

Investing in real estate can be difficult, though. Managing a rental property can be time-consuming and difficult. Even when you hire someone else to do it for you, there are a number of concerns to contend with. Besides, you might not have the money available to you to make such a large purchase, and you might be reluctant to jump through all the hoops necessary to get a mortgage for an investment property.

Enter REITs. These are investments that group together different real-estate-related assets. It’s a lot like investing in a fund, and you can trade these on exchanges. Plus, REITs pay dividends. So you can get a tidy income as well as things progress. If you want to add real estate to your portfolio, without the hassle of actually owning real estate, the REIT can be an option.

Hard Assets

Another option is to add hard assets to your portfolio. Many investors like to have a little gold in their portfolios. If physical gold is too expensive for you, silver can be a reasonable alternative. It costs much less, but often holds its value similar to gold, and mimics gold movements. Another consideration is to purchase items that have the potential for appreciation, such as fine art or jewelry, or even certain collectibles.

When dealing with physical items like this (including precious metals), you have to be wary of the tax situation. The capital gains tax on these items is currently 28 percent; you don’t get the same treatment as you would with long-term capital gains on stocks.

Currency and Commodity ETFs

I recently added a commodity ETF, specializing in precious metals, to my portfolio. Because ETFs trade like stocks on the exchange, they are easy to buy and sell, and make it easy to add exposure to commodities and currencies. If you are looking to spice up your portfolio and possibly see some growth, this approach can work.

However, you still need to be careful. Remember that you aren’t actually investing in these assets directly. Additionally, when you invest in futures ETFs you run the risk of contango, which is when the future price of an underlying asset is out of step with what is happening right now. This can have strange effects on your returns, and you need to be aware of the risks. If you have the stomach for it, this can be a good way to boost your returns and protect your portfolio against the risks that can come with a more “traditional” asset allocation.

Bottom Line

If you want a little more diversity in your portfolio, it can make sense to add these other items, just to shake things up a little bit. But realize that there are risks — including losses — that come with any investment. You run the risk of loss, and in some cases, the risk might be even greater. Many investment experts suggest that you limit your inclusion of these other assets to a total of no more than 10 to 15 percent of your portfolio.

Consider your situation, and think about what would boost your portfolio. Make it a point to look for ways to add diversity, without adding assets you don’t understand.