Any classical music composer will tell you that creating a symphony requires a delicate balance of sounds, melodies, and harmonies. Each instrument creates unique sounds and vibrations that, when heard alone, may not be particularly compelling. However, when the orchestra plays in unison, the end result can be a masterful composition. Hence, the true art of creating a masterpiece—arranging melodies and blending sounds. In this respect, composers and investors share some similarities. Successful investing typically combines a number of different investments in order to create a portfolio that is “in tune” with the investor’s goals and objectives. It’s no coincidence that such a technique is the foundation for one of the most basic financial investment principles—diversification.
Diversification is the process of attempting to decrease financial risk by investing monies in different asset categories. To effectively diversify, many financial professionals recommend investing in at least three different asset classes. The major asset categories include: stocks; bonds; mutual funds (which can comprise equities, fixed-income securities, or a combination of both); real estate; and cash (saving and checking accounts, certificates of deposit (CDs), money market accounts, and Treasury securities).
Overall, diversification may help reduce investment risk while achieving potentially higher returns. That’s because different categories of investments react differently to changes in the economy. For example, while stock values might be plummeting, bond values may be rising or remaining level. With a well-diversified portfolio, you can ultimately come to own many asset categories, thus potentially reducing the impact of the economy on your total investments.
Creating Your Own Ensemble
Before deciding where to invest, you should review your personal financial goals and ask yourself the following questions:
o What are my goals for my money?
o How can I keep inflation from eroding my purchasing power?
o How much risk am I willing to take with my money?
o Will I be comfortable holding investments with daily price fluctuations?
Many investors use diversification as the foundation of their portfolios. However, it is essential to realize that diversification does not eliminate risk or guarantee a profitable investment return.
To reduce risk, your financial portfolio should reflect your own personal financial goals and investment style. Among other factors, your age, income, expenses, family responsibilities, temperament (are you a risk-taker or do you prefer to play it safe?), can influence how you should build your portfolio.
Hitting the High Notes
With these factors in mind, here are some basic points to consider when investing:
o Own only as many stocks and mutual funds as you can safely monitor. Mutual funds, by their nature, are diversified since they consist of a variety of either stocks, bonds, or a combination of both. In addition, you can further diversify by investing in several funds with varying investment objectives.
o Review your portfolio periodically to help identify opportunities to put extra money into promising funds or securities and move out of ones showing problems.
o Many financial products are available that can help you build a suitable portfolio, regardless of your needs and goals. However, unless you have a great deal of financial acumen, it’s a good idea to consult a qualified financial professional before purchasing any financial products.
o When evaluating any investment, bear in mind that past performance is not indicative of future results, and shares may be redeemed for more or less than their original cost.
o Mutual funds are sold by prospectus. This document includes important information on charges, expenses, and risks. To receive a current prospectus, contact your registered representative. Always read the prospectus carefully before investing.
Arranging a Masterpiece
One of the biggest challenges facing the average investor is deciding how to allocate personal savings or retirement assets. Naturally, most individuals hope to create an investment portfolio that is consistent with their personal objectives and risk tolerance level. However, the lure of potentially high rates of return can easily skew an investor’s objectivity, resulting in unrealistic expectations and unnecessary exposure to risk. Thus, it is important to adhere to a diversified investment strategy that conforms to your short- and long-range goals. With a little bit of patience, your future may bring music to your ears.