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Coronavirus Lessons: Why Diversifying Your Portfolio is Important

If you’re a beginning investor, it’s likely you’re concentrating on building your portfolio.  But as important as it is to build that portfolio, you should also ensure that it’s diversified. The current market uncertainty caused by COVID-19 is a perfect example of why diversification is so important.

Why is a diversified portfolio so important?

There are three key reasons why diversifying is important:

  1. A diversified portfolio helps minimize risk. Stocks can be a risky investment at any time, but with a diversified portfolio, you can help minimize the risk by spreading that risk among a variety of investments.
  2. Diversifying can help investors maintain capital. Someone purchasing stock at the age of 30 has a much different investment goal than someone age 50. For older investors, it may be much more important to maintain capital than it is to increase capital.
  3. You’ll have a much better chance at generating dividends if your portfolio of stocks is diversified. When one stock is performing well, chances are that another stock has dipped. By having a significant investment in both, you’ll help to offset any potential losses from underperforming stock.

It’s also common for one particular type of asset to perform better over a specific period of time, depending on external factors such as

  • Current interest rates
  • Currency markets
  • Current market conditions

But it’s also important to remember that while one investment may be outperforming others, the standard is that there is no particular investment that will continually outperform others over the long term.

But what is a diversified portfolio?

A diversified portfolio is one where investments vary, with exposure to one particular type of asset is limited. Diversifying can look like two very different things to young investors and those nearing retirement age. Young investors are much more likely to be comfortable riding out the peaks and valleys of their investment portfolio, while investors nearing retirement age are more likely to be interested in slow growth and a more consistent performance without the volatility that more risky investments may face.

In order to truly diversify your investment portfolio, many professionals recommend that your portfolio consists of the following:

  1. Domestic Stocks. Stocks are perhaps the most volatile investment in a portfolio, but they also represent the best chance for growth. Short term investment in stocks carries the biggest risk, but stocks can also provide the biggest reward if they are held on to for a significant amount of time.
  2. Bonds. Considered less volatile than stocks, bonds can provide a shield against market instability created by stock investments. Stocks also typically provide regular interest income. For those looking for a more significant return, high-yields bonds can be purchased, but they also carry a higher-risk.
  3. Money Market Investments. While ultra-conservative, money market accounts and similar investments such as a short-term CD can provide stability and safety that other investment options may not.
  4. International Stock. International stock can provide a higher return than their U.S. counterparts, but they can also carry a higher risk. However, for those looking to diversify their portfolio, international stock can be a good addition.

The key to diversification is to find the right balance between risk and stability and add accordingly, which allows you to reach your goals while also worrying less. In the wake of Coronavirus, and the potential long-term affects it will have on the markets, your ability to handle current market volatility depends on diversification.

How to create an emergency savings fund in wake of COVID-19

If the Coronavirus’ effect on the markets has taught us anything, it’s that every single person reading this should start the process of creating an emergency fund. This is not just an idea, nor is it a savings account, but rather, it is a separate pool of money to only use in emergencies. So, how do you even start the process of creating an emergency savings fund?

    1. You should look to chat with your local financial advisor on your specific needs. A good rule of thumb is to have at least three months of income saved in your emergency fund in case you need it. This will allow you to continue to pay off bills or other expenses if you lose your job or need to take an extended leave in case of medical or family emergencies.
    2. During this chat, you can start to structure your savings to ensure that your savings and emergency fund goals are met. For instance, if you had $500 for savings per cheque, you can put $100 in your emergency fund, $100 in your savings and $100 in your 401(k).
    3. You should look to continue to build your savings over time and keep a dedicated emergency fund. Most banks now allow automatic withdrawals to other accounts, which makes saving even more effortless! Make sure to continue to make regular contributions, and your savings and emergency fund will grow over time.
    4. As your current situation change, continue to check-in with your financial advisor to see if you need to change your existing structure. You may need to change the amount of money you are putting in, and these adjustments are easy to make on the fly. One thing to note, once your emergency fund is filled, you can start to filter that money into other savings vehicles. This will allow you to meet your savings goals faster without changing your current situation or lifestyle.
    5. Finally, you can also use other income that comes in during the year to help build your emergency fund even quicker. For instance, you may run into some extra money from a side gig or have an unexpected bonus come in. Why spend this extra income, when you can utilize it to top-up your emergency fund and meet your saving goals even faster!

The long-term effects of COVID-19 are unclear, so the time to create your emergency savings fund is now! Now is the time to set up a meeting with your financial advisor and discuss how you can reach your savings goals with an emergency fund!