How to Get a Well-Diversified Portfolio

by Leslie McClintock

Investing involves risk, but a good investment portfolio will survive many kinds of risk because it includes some assets that will perform well --- or at least hold their value --- in any economic environment. That means a well-diversified portfolio will include assets that perform well in bull markets, bear markets, inflationary periods and deflationary periods, and will be resilient in the face of market shocks such as oil crunches, currency crises, and wars.

1. Diversify your stock portfolio. It's not enough to own shares in an S&P; 500 index fund and think because you own 500 stocks, you're diversified. You're only diversified among U.S. large caps, denominated in dollars. A diversified stock portfolio also includes mid-cap and small-cap stocks, as well as stocks in companies from around the world.

2. Own bonds. Stocks may grab the headlines on TV, but bonds are designed to kick out a regular income through thick and thin. While bond prices will fall when interest rates rise, they will still continue to generate income and are generally subject to less volatility than stocks. Some bonds, however, like high-yield bonds and zero-coupon bonds, can be extremely volatile in the short term. A special type of bond, the Treasury Inflation Protected Security, or TIPS, automatically adjusts to keep up with inflation and can be a valuable inflation hedge in your portfolio.

3. Invest in real estate. You can gain a lot of exposure to this asset class simply by owning your own home. While home prices can decline --- and many prices declined sharply between 2007 and 2011 --- real estate tends to hold up well against inflation. Rental real estate can generate a steady income once you have paid off the mortgage. You may also convert your home to a source of income in retirement, supplementing pensions, savings and Social Security.

4. Consider commodities and precious metals. These assets do not generate an income in and of themselves. But they do provide a valuable hedge against a declining dollar. In the event of a general economic collapse, these assets may indeed form the bedrock of your portfolio. Be prepared for them to lag, however, during good times.

5. Own cash. Cash and cash equivalents provide needed liquidity to respond to crisis and to opportunity. Examples of cash and cash equivalents include savings accounts, certificates of deposit and money market accounts.

6. Own annuities, which help protect against the possibility that you will outlive your assets, running out of income before you run out of time. A lifetime income annuity comes with a guarantee that your income will continue as long as you are alive. Some deferred annuities also come with guarantees against market loss or with a minimum guaranteed income or withdrawal.

7. Own assets that are taxed in a variety of different ways. For example, consider dividing retirement assets between tax-deferred retirement savings vehicles such as IRAs and 401ks, tax-free vehicles such as Roth IRAs and permanent life insurance cash values, and fully taxable accounts outside of retirement accounts that function under capital gains tax rules, rather than income tax rules. This way, if Congress makes any major changes to the tax code, it may only affect a small portion of your portfolio.


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