When is a portfolio diversified

Commodities include wheat, oil, and gold. For example, wheat prices would rise if there is a drought that limits supply. Oil prices would fall if there is excess supply.

As a result, commodities don't follow the phases of the business cycle as closely as stocks and bonds do. Here are six asset classes to help build a diversified portfolio:. Companies of different sizes should be included. Company size is measured by its market capitalization, so include small-cap, mid-cap, and large-cap stocks in a portfolio. They respond differently depending on the phase of the business cycle. Fixed income investments pay an agreed-upon return on a fixed schedule.

These are guaranteed by the federal government. Municipal bonds are also very safe. You can also buy short-term bond funds and money market funds that invest in these safe securities. Corporate bonds provide a higher return with greater risk. The highest returns and risk come with junk bonds.

These include companies from both developed and emerging markets. You can achieve greater diversification if you invest overseas. International investments can generate a higher return, because emerging-market countries are growing more rapidly. They are also riskier investments, because these countries have fewer central bank safeguards in place.

They are susceptible to political changes and are less transparent. Foreign companies do well when the dollar is strong. That makes their exports into the United States cheaper than when the dollar is weak. These include both corporate and government issues. They provide protection from a dollar decline. They are safer than foreign stocks. Alternative investments can include a variety of assets and generally make up the smallest allocation, compared to the other asset classes.

Examples of alternatives include real estate, commodities, hedge funds, venture capital, derivatives, or cryptocurrencies.

Commodities can include natural resources such as gold or oil. Gold is considered a solid part of a diversified portfolio because it's the best hedge against a stock market crash. Research shows that gold prices rise dramatically for 15 days after a crash. Gold can also be a good defense against inflation. It is also uncorrelated to assets such as stocks and bonds.

Most investment advisors don't count the equity in a home as a real estate investment. They assume you will continue to live there for the rest of your life. That attitude encouraged many homeowners to borrow against the equity in their homes to buy consumer goods. When housing prices declined in , many homeowners owed more than their property was worth.

As a result, many people lost their homes during the financial crisis. Some walked away from their homes, while others declared bankruptcy. Many investment advisors consider your home to be a consumable product, like a car or a refrigerator, not an investment. Aggregate Bond Index, which tracks the performance of U. It is not possible to invest directly in an index.

Allocation figures are rounded to the nearest whole number. Important disclosures Investing involves risks, including the potential loss of principal.

Standard deviation is a statistical measure of the historic volatility of a portfolio. The larger the deviation, the larger the standard deviation and the higher the risk. Collateralized mortgage obligations CMOs are more complicated versions of mortgage-backed securities that consist of multiple classes of securities designed to appeal to investors with different investment objectives and risk tolerances.

Portfolios that have a greater percentage of alternatives may have greater risks. Diversification does not guarantee a profit or eliminate the risk of a loss.

Related viewpoints June 13, What's a growth stock? A value stock? Equity market style explained John Hancock Investment Management. July 14, What happens in a recession? John Hancock Investment Management. Explore the latest thinking from our network Sign up to get market insight and analysis delivered straight to your inbox. Subscribe now. Small caps and large caps rise and fall together.

Find strong businesses and invest in those regardless of what the total market cap is. Hedge funds and nontraded REITs are two favorites of the investment salesmen who tout diversification.

The former are sold as go-go high-octane vehicles and the latter as supersafe dividend plays with zero volatility. On average, both perform poorly over time. There are two things I tell my clients that make sense. Stock movements are propelled by underlying economic drivers, so by owning a stock with exposure to another type of asset, you are diversified into that other asset.

Suburban homes, for example. Owners of KB Home — a company that has been making extraordinary money selling houses to Texas oil workers who might now be looking for other work — is a case in point:. And AvalonBay has been an especially impressive stock of late:. Second, assume that the stock market will have bad years. Since , U. Tell your financial adviser to work with you to prepare a defense strategy for when storm clouds appear i. Not that you have to follow my plan, but around here, we like moving our clients into cash when certain bear market thresholds are crossed.

This is a BETA experience. You may opt-out by clicking here. This practice is designed to help reduce the volatility of your portfolio over time. One of the keys to successful investing is learning how to balance your comfort level with risk against your time horizon. Invest your retirement nest egg too conservatively at a young age, and you run the risk that the growth rate of your investments won't keep pace with inflation.

Conversely, if you invest too aggressively when you're older, you could leave your savings exposed to market volatility, which could erode the value of your assets at an age when you have fewer opportunities to recoup your losses.

One way to balance risk and reward in your investment portfolio is to diversify your assets. This strategy has many complex iterations, but at its root is the simple idea of spreading your portfolio across several asset classes.

Diversification can help mitigate the risk and volatility in your portfolio, potentially reducing the number and severity of stomach-churning ups and downs. Remember, diversification does not ensure a profit or guarantee against loss. Stocks represent the most aggressive portion of your portfolio and provide the opportunity for higher growth over the long term.

However, this greater potential for growth carries a greater risk, particularly in the short term. Because stocks are generally more volatile than other types of assets, your investment in a stock could be worth less if and when you decide to sell it. Most bonds provide regular interest income and are generally considered to be less volatile than stocks.

They can also act as a cushion against the unpredictable ups and downs of the stock market, as they often behave differently than stocks. Investors who are more focused on safety than growth often favor US Treasury or other high-quality bonds, while reducing their exposure to stocks. These investors may have to accept lower long-term returns, as many bonds—especially high-quality issues—generally don't offer returns as high as stocks over the long term.

However, note that some fixed income investments, like high-yield bonds and certain international bonds, can offer much higher yields, albeit with more risk. These include money market funds and short-term CDs certificates of deposit. Money market funds are conservative investments that offer stability and easy access to your money, ideal for those looking to preserve principal. In exchange for that level of safety, money market funds usually provide lower returns than bond funds or individual bonds.

An investment in the fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Stocks issued by non-US companies often perform differently than their US counterparts, providing exposure to opportunities not offered by US securities.

If you're searching for investments that offer both higher potential returns and higher risk, you may want to consider adding some foreign stocks to your portfolio. Although these invest in stocks, sector funds, as their name suggests, focus on a particular segment of the economy. They can be valuable tools for investors seeking opportunities in different phases of the economic cycle.

While only the most experienced investors should invest in commodities, adding equity funds that focus on commodity-intensive industries to your portfolio—such as oil and gas, mining, and natural resources—can provide a good hedge against inflation.