Diversification is one of the easiest and most effective ways to maximize the return in your portfolio for a given amount of risk.
Typically, a diversified portfolio consists of a number of different types of securities across various market sectors. For example, a well-diversified investment portfolio might consist of large- and small-cap stocks, international stocks and bonds, commodities and various income investments, like preferred and/or dividend-paying stocks. Traditionally, diversified portfolios required large sums of money to buy all of these different types of investments. However, these days, a diversified portfolio can be had without much cost at all.
Last updated: May 14, 2021
Use a $0 Commission Broker
One of the biggest advances in making portfolio diversification available to everyone has been the recent trend towards $0 commissions from online brokers. The biggest names in the online space, from Fidelity and E-Trade to Charles Schwab and TD Ameritrade, have all moved to $0 commissions for most online stock and ETF trades. Now, any customer can buy nearly any stock or ETF they wish without paying a dime in fees or commissions, which removes one of the largest obstacles to portfolio diversification — cost. You’ll still need some capital to buy all of the diverse elements of your portfolio, but now you can do it without paying an annual fee or hundreds of dollars per trade — or even $7 per trade, which used to be the gold standard for online brokers.
Buy No-Load Mutual Funds
Even before the era of $0-commission trading, no-load mutual funds were the entry point to a low-cost, diversified portfolio. And to some degree, no-load mutual funds still serve that very same purpose. By and large, the strength of a mutual fund is its inherent diversification. In many cases, you can buy a simple broad-market mutual fund and have instant diversification in a single investment. Whether you need an investment spanning an entire world’s worth of investments or simply a particular type of mutual fund to diversify the holdings you already own, a no-load mutual fund is a way to get it, without paying any commissions or fees upfront.
Use Low-Cost ETFs
Commissions aren’t the only obstacle to low-cost portfolio diversification. Some mutual funds and ETFs may have low or no commissions but charge high internal expenses. These hidden fees are rarely known to the average investor, but over time they can significantly eat away at returns. When you are diversifying your portfolio through a zero-commission broker, one option to look at is low-cost ETFs. The proliferation of low-cost ETFs means that you can own nearly any sector or the market that you would like, including global stocks, micro-cap stocks, real estate investments or commodities. You can plug these ETFs into your broader portfolio to fill certain diversification gaps, or you can buy all-in-one ETFs that cover a diverse range of securities in a single investment. Many low-cost ETFs charge annual expenses of less than one penny per $1,000 you invest.
Buy Fractional Shares
One of the most groundbreaking revolutions in the brokerage industry in the past few years, in addition to the move towards zero commission, is the ability for investors to purchase fractional shares of stock. When you buy fractional shares of stock, the individual share price of a company doesn’t matter. All that matters is the dollar amount you wish to purchase. Shares of Amazon, for example, have recently traded at the lofty price of over $3,200 per share. For many investors, it would take time to save up enough money to buy even a single share of Amazon, and then all of their money would be tied up in a single stock. But with fractional-share purchasing, you can put $5 into Amazon, $5 into Facebook, $5 into Google, and $5 into whatever other available stock you’d like, offering the potential for immediate diversification at a low cost.
Buy an S&P 500 Index Fund or ETF
The S&P 500 index isn’t completely diversified — it only represents the largest companies in America — but for a single, low-cost purchase, you can hardly do better if you’re looking for exposure to the U.S. market. These days, you can own the entire S&P 500 index in an ETF and pay just 0.03% a year in internal expenses, which amounts to just $3 per year on a $10,000 investment, or $0.30 per year on a $1,000 investment. Coupled with the use of a zero-commission broker, this one-two punch is a great way to make sure that as much of your investment capital as possible goes towards your actual investments instead of towards fees.
Use a Robo-Advisor
Another relatively recent boon for low-cost diversification has been the introduction of so-called “robo-advisors.” These computerized portfolios are based on algorithms that choose investments based on inputs from customers regarding financial goals and risk tolerance. Portfolio monitoring and rebalancing typically come included with the annual management fee, which can be as low as 0.25% per year or even lower. As most robo-advisors also require no minimum balance to open an account, they can be a great way for newer investors to get a foothold in the investment world without spending a lot of money to diversify their portfolios.
Buy a ‘Fund of Funds’
Some fund companies allow investors to purchase a “fund of funds,” which provides diversification within diversification. Whereas traditional mutual funds invest only in the specific areas outlined by the fund’s prospectus, a fund of funds actually takes investor money and uses it to purchase a variety of different mutual funds. Thus, the money used for a single purchase of a fund of funds actually owns a wide variety of different funds, all under the same umbrella. One of the most well-known examples of a “fund of funds” is the Vanguard STAR fund, which actually offers exposure to 10 different actively managed Vanguard funds. This is one of the easiest ways for an investor to gain instant diversification through a single no-load fund purchase.
Join an Investment Club
An investment club is a great way for new or even veteran investors to benefit from the power of group purchasing. In an investment club, individuals pool their money together to purchase securities decided on by the group. In this way, the small purchasing power of individuals is aggregated so that larger, and potentially more cost-effective, buys can be made. Some investment clubs can get discounted access to professional money managers, while others may qualify for additional services or benefits due to their larger purchasing power. If nothing else, membership in an investment club can teach beginners and experts alike about how to analyze and buy securities. Over the long haul, this can pay even greater dividends than simply providing access to low-cost diversification.
Diversify Your Short-Term Money at Your Bank
When you’re working on diversifying your account, don’t forget about your short-term, conservative money as well. While it’s relatively easy to diversify your long-term investments via a variety of mutual funds, individual stocks and other securities, some investors overlook the importance of earning the most money they can on their short-term funds. Most banks, especially online banks, offer a variety of higher-yielding short-term investments, from high-yield savings accounts to CDs. Typically, these types of investments don’t have any commissions or fees involved, meaning you can shift your short-term money into them without the costs derailing the benefits. In the case of CDs, however, be sure to check the early withdrawal penalties if you think you might need to access those funds prematurely.
Buy US Treasuries Straight From the Government
If you’re looking for a low-cost way to balance out the stocks in your portfolio, there’s no better option than getting U.S. Treasuries direct from the source, the U.S. government. Via the government’s Treasury Direct website, you can buy Treasury bills, notes or bonds without paying any fees or commissions. U.S. Treasury securities are generally considered the safest and most liquid investments in the world, they are great diversifiers for the riskier parts of your portfolio.
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