{"id":34776,"date":"2022-12-15T10:09:53","date_gmt":"2022-12-15T15:09:53","guid":{"rendered":"https:\/\/www.escapeartist.com\/?p=34776"},"modified":"2022-12-15T13:52:27","modified_gmt":"2022-12-15T18:52:27","slug":"four-steps-to-building-a-diversified-investment-portfolio","status":"publish","type":"post","link":"https:\/\/www.escapeartist.com\/blog\/four-steps-to-building-a-diversified-investment-portfolio\/","title":{"rendered":"Four Steps to Building a Diversified Investment Portfolio"},"content":{"rendered":"

Four Steps to Building a Diversified Investment Portfolio<\/strong><\/h1>\n

Diversification is a cornerstone of today\u2019s approach to successful long-term investment.\u00a0 <\/span>For\u00a0investors, one of the most important considerations is how to manage portfolio risk.<\/p>\n

Diversification is the practice of building a portfolio with a variety of investments that have different expected risks and returns.<\/p>\n

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Most people tend to see investing as merely <\/span>stock trading<\/span>, since stocks usually get the most flashing headlines in the news. Nevertheless, in practice, financial advisors and money managers approach the art of investing by combining different assets to properly diversify their holdings.<\/span><\/p>\n

It is important to note that the benefits of diversification extend beyond the common phrase \u201cdon\u2019t put all your eggs in one basket\u201d as an adequately diversified portfolio doesn\u2019t just minimize risk, but it also produces an optimal combination of risk and return by incorporating various types of financial assets.<\/span><\/p>\n

The theoretical foundation of diversification for investments is known as <\/span>modern portfolio theory<\/span><\/a> (MPT) and it was first presented by Nobel prize winner Harry Markowitz back in 1952 in an article known as \u201cPortfolio selection\u201d.<\/span><\/p>\n

This theory states that there\u2019s a certain combination of financial assets that produces the optimal risk\/return relationship, after which any additional unit of return must be earned by taking an extra measure of risk.<\/span><\/p>\n

In order to estimate this, Markowitz proposed that investors should evaluate the potential return of an investment by analyzing its historical performance, while also determining its risk, which can be quantified as the standard deviation of these results during that same time frame.<\/span><\/p>\n

\"graph\"As a result, investors can calculate the risk\/return produced by each financial asset they intend to incorporate into their portfolio and they can ultimately design the portfolio by determining the exact combination of assets that produces the highest return at the lowest risk possible.\u00a0<\/span><\/p>\n

Even though this all sounds fairly technical, the essence of this theory can be applied to your investments, at least to some extent, without having to run multiple scenarios and combinations of different assets in an excel spreadsheet, as the broad concept of diversification can benefit your portfolio even if you don\u2019t go into the technicalities of modern portfolio theory.<\/span><\/p>\n

To assist you in this endeavor, the following article provides 4 recommendations that should help you in diversifying your investment portfolio to cushion the impact that a bad performing asset class may have on your investment returns.<\/span><\/p>\n

1.\u00a0 Diversify Your Asset Classes<\/strong><\/h3>\n

Financial instruments have evolved from simply stock and bonds to a wide range of securities that are classified into <\/span>asset classes<\/span>.\u00a0 This is the backbone of a well-balanced and diversified<\/a> portfolio.\u00a0<\/span><\/p>\n

These assets have very unique characteristics and this is the primary reason why they are classified separately.<\/span><\/p>\n

The most common asset classes in modern financial markets are:<\/span><\/p>\n