Diversification reduces the risk or volatility in your investment portfolio and increases returns. A diversified portfolio is one that invests in a variety of different types of assets.
A good way to diversify your portfolio is by making investments online. If you hold diverse types of assets, when one asset class falters, you’ll still have others that perform well — and thus, you’ll minimize risk and increase returns. An undiversified portfolio, on the other hand, can leave you with nothing if your investment fails. To better understand how to easily diversify your portfolio, check out the following eight online investments — and decide if online trading is right for you.
Achieve Portfolio Diversification With Asset Allocation
Asset allocation is the practice of dividing your investment portfolio among various asset categories such as stocks, bonds, real estate, currencies, natural resources and more. Certain asset classes are riskier than others; for example, bonds tend to have lower risk and lower returns, whereas stocks exhibit high risk and returns. Use this list of eight best investments when mapping out your diversification strategy.
1. Individual Stocks
An individual stock represents part ownership in a company. If you’re just starting to invest, make sure you find the best online stockbroker for beginners. Look for an easy-to-use platform and resources like online tools, seminars, research and educational opportunities.
Advantages of Individual Stocks
- You own part of a company.
- Owning 12 to 18 diverse stocks can provide 90 percent of the diversification benefits, according to Morningstar.
- Online stock trading is easy — all you really need is a computer and some good intuition.
Disadvantages of Individual Stocks
- Buying stocks can be risky — you have no guaranteed return.
- Prices of stocks can rise and fall significantly.
2. Individual Bonds
A bond is similar to a loan. When you buy a bond, you’re lending money to the company, government or entity that created the bond. In exchange for the bond, the issuer agrees to pay you regular interest or coupon payments.
Individual bonds, although less risky than stocks, are not as safe as bank savings accounts. Bonds are rated according to risk level, and lower-rated bonds pay higher interest to compensate for greater risk.
Advantages of Individual Bonds
- Bond prices usually don’t fluctuate as much as stock prices.
- You might be able to find bonds that provide some income stability.
Disadvantages of Individual Bonds
- Bonds do not provide as high long-term investment returns as stocks.
- When interest rates rise, bond prices fall.
3. Mutual Funds and ETFs
It’s easy to broadly diversify your investment portfolio by investing in mutual funds and exchange-traded funds. You can buy a mutual fund online from the investment company that created the fund. The fund combines your money with other investors’ money and invests the funds in various individual assets like:
- Real estate
ETFs are priced and traded throughout the day. In contrast, mutual funds are only priced at the end of the day. Mutual and exchange-traded funds offer two types of investment styles: passive index fund investing and active investing.
Advantages of Mutual Funds and ETFs
- You’ll achieve solid diversification by investing in mutual funds or ETFs.
- ETF prices fluctuate through the day in real time, making them a good choice if you’re a day trader.
- You can short sell ETFs, which means you borrow securities from your brokerage firm and sell them on the market at the same time in the hopes the borrowed securities’ price will go down and you can buy them back later for a lower price.
Disadvantages of Mutual Funds and ETFs
- The risk level of your fund depends on the investments within that ETF or mutual fund.
- You’ll pay a commission to invest in an ETF.
- It can be tough to evaluate and research different mutual funds because they provide their net asset values.
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4. International Funds
It’s complicated to invest in individual international stocks and bonds. For broad diversification, you might choose a world stock market fund like Vanguard’s Total World Stock Market Fund. If you want to bet on a single country or market, there are regional funds like Asia Pacific or Fidelity’s Emerging Markets Fund. Most investors should take a look at international investment opportunities when diversifying their online investment portfolios.
Advantages of International Funds
- By investing outside the U.S., you’ll open up a number of potential investment opportunities available to you.
- If you spread your risk over different markets, you might experience less volatility.
Disadvantages of International Funds
- A country’s political volatility could affect the value of the market you invested in.
- Many countries use different reporting standards than the U.S., which could make it difficult to compare investments.
5. Peer-to-Peer Lending
Lending to others via online social lending portals can be a great way to diversify but recognize the risks. Prosper and Lending Club, two of the biggest players in the P2P lending space, allow ordinary investors to lend to others through their platforms. Because lending is risky, these platforms recommend extreme diversification across loans.
Advantages of Peer-to-Peer Lending
- Returns on P2P lending are comparable to those of the stock market.
- You can choose who you want to lend money.
- You can spread your capital among different loans.
Disadvantages of Peer-to-Peer Lending
- Little data exists to indicate how these investments might react to a major economic decline.
- Any interest you earn will be subject to taxes.
An option is a contract, not a financial instrument. The contract gives you the right — not the obligation — to buy or sell a specific number of shares of a financial security at a previously determined price, within a specific time period. The underlying security might be a stock, currency, fund or another type of investment. You buy and sell options on securities marketplaces.
Advantages of Options
- Options sometimes can give you returns of 100 percent or more, which provides great leverage.
- You can sell options against shares that you already have to earn extra income.
Disadvantages of Options
- Options are somewhat complicated and are best left to more advanced investors.
- Certain types of options can be very risky and might result in the loss of your entire investment.
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A futures contract is an agreement to buy or sell a commodity, financial instrument or security at a predetermined future date for a specific price. If you decide to speculate in futures trading you can choose from commodities, stocks, Treasury bonds, global currencies and more.
Advantages of Futures
- Futures are leveraged investments, so you can invest a small amount of the contract’s value.
- Considered very liquid, futures enable you to place buy and sell orders quickly.
- You can hedge against loss in a volatile market with futures.
Disadvantages of Futures
- Futures are very risky investments.
- You must make an initial investment in a futures trading account that could range between $2,000 and $5,000.
- Liquidity for futures differs among contracts — check the volume of the futures market before you trade.
Foreign currency exchange trading is a strategy to capitalize on the relative movements of international currencies. Forex investing is complex and traders can lose more money than their initial investments.
Advantages of Foreign Currency Exchange Trading
- An accessible market for individual traders; you can set up a forex account quickly and trade 24 hours a day, five days a week.
- You might see faster returns than in other markets because the forex market features high liquidity and moves fast.
Disadvantages of Foreign Currency Exchange Trading
- The forex market is extremely volatile.
- You could experience substantial losses.
- If you want to ensure profitable trading you must constantly monitor the changes in this fast-moving market.
Diversify Your Portfolio
Ultimately, ordinary investors can gain excellent diversification with online investing. From owning several stock and bond mutual funds to a buying a suite of various asset classes, there are alternatives for all types of investors -from the most conservative, to aggressive, and even robo-advisors.
Once you decide to diversify by investing online, make sure you find the best online investment sites. The best online stockbroker should offer strong customer support, affordable commissions and lots of advice for both newbies and old hands.
Barbara Friedberg contributed to the reporting for this article.