What Advice Would You Give for Diversifying An Investment Portfolio?

What Advice Would You Give for Diversifying An Investment Portfolio?

In the quest to build a robust investment portfolio, we've gathered wisdom from top financial experts, including CEOs and Chief Investment Officers. From focusing on long-term objectives to investing in sustainable growth opportunities, here are five key strategies these professionals recommend for diversifying your investments effectively.

• Focus on Long-Term Objectives
• Consider Expenses, Taxes, and Risk
• Avoid Over-Diversification
• Diversify Across Multiple Asset Classes
• Invest in Sustainable Growth Opportunities

Focus on Long-Term Objectives

Even in shaky markets, I consistently advise my clients to stay focused on their big-picture objectives rather than worrying too much about the day-to-day ups and downs. Recently, when things were really volatile, a client came to me feeling anxious about his investments. I reminded him of the long-term plan we had put in place, which is all about slow and steady growth while managing risk, not chasing short-term profits. Sticking to our core approach helps insulate his portfolio from temporary dips and sets him up well for the future. It just goes to show how important it is to stay level-headed and have a well-rounded strategy.

Consider Expenses, Taxes, and Risk

There are three critical factors in building a successful portfolio:

1. Expenses – By keeping investment expenses low, your investments will perform better long-term. Statistically, a passively managed ETF is likely to outperform its higher-expense-ratio actively managed mutual fund counterpart.
2. Taxes – In the non-qualified space, using municipal bonds as your fixed income allocation, using low turnover instead of high turnover funds, and avoiding high-dividend-paying stocks can all play a major role in your after-tax real rate of return.
3. Risk – According to the Corporate Finance Institute, "Modern Portfolio Theory assumes that investors are risk-averse; for a given level of expected return, investors will always prefer the less risky portfolio." Some great ways to minimize the level of risk a portfolio carries are distributing funds into different asset classes, different industries, different investment countries of origin, and different institutions.

Avoid Over-Diversification

There is such a thing as being overly diversified. When people think of diversification, they often consider an index fund, which holds hundreds of different stocks. Diversifying over more stocks lowers risk, but it also lowers the performance potential. At any given time, there may be only a few dozen outstanding stocks. To diversify into hundreds reduces exposure to the stocks that are driving market indices higher. From a statistical perspective, assuming investments are uncorrelated, 20-30 different holdings is plenty to realistically diversify against catastrophic risks.

Diversify Across Multiple Asset Classes

One crucial piece of advice I would give to someone looking to diversify their investment portfolio is: Don't overlook the importance of diversifying across multiple asset classes, not just within the stock market.

Too often, investors think they are properly diversified by holding a variety of stocks across different sectors and geographies. However, all stocks still expose you to the oscillations and potential downsides of the broader equity markets.

True portfolio diversification comes from spreading your wealth across lowly-correlated asset classes that don't all move in lockstep with the stock market. This can help mitigate volatility, minimize drawdowns during market corrections, and allow you to benefit from varying market cycles.

Some key asset classes to consider incorporating alongside stocks include fixed income/bonds, real estate (REITs, private funds), commodities, and alternative investments (private equity, venture capital).

Even within stocks and bonds, you'll want to diversify across market caps, sectors, geographies, and investment styles like growth versus value.

The right asset allocation blend will depend on your individual goals, risk tolerance, and time horizon. But for most investors, having at least 10-30% of your portfolio in assets other than stocks can provide meaningful diversification benefits over the long run.

Invest in Sustainable Growth Opportunities

In my experience, the secret sauce of alpha creation is investing in structural growth opportunities and companies with sustainable moats, underpinning good visibility on earnings/cash-flow growth and improving returns on capital over a long-term investment horizon of at least five years. Importantly, invest not necessarily in cheap stocks or stocks at cheap valuations, but in good businesses at reasonable valuations and businesses that are mispriced by the market.