Build a Diversified Portfolio

The keys to long-term wealth building are formulating a good plan, sticking with it, and gathering together a well-diversified portfolio. Consider the following when determining what to do with your serious, long-term money.

Steps

  1. Create an investment plan. Learn how to invest in stocks and bonds. Ask experienced investors for advice.
  2. Stick with your investment plan. If you must adjust your investment plan, do it for the right reasons, such as a change in the long-term outlook for one of your investments or the realization that an investment no longer meets your goals.
  3. Put your money into different investments that have low correlation with each other. By spreading your money among a variety of investments that may rise and fall at different times, you'll avoid taking those big "hits" that your entire portfolio could suffer when one asset class is hit hard. You will also need to "rebalance" your holdings occasionally (at least once a year) to make sure the percentages of your portfolio taken up by different assets still fit your risk tolerance and time horizon.
  4. Reduce the size of an investment that's too large. If you put a large amount of money in a single stock, for example, you are taking a substantial risk. Check current capital gains rates for your bracket. If they are low by historical standards, take advantage of the opportunity to sell off shares of a stock, and move some of that money into other asset classes, thereby diversifying your portfolio. Having too much in one investment is a risk that may not be worth taking.
  5. Keep investing. Although good past performance does not guarantee future success, over the long term stocks have significantly outperformed all other asset classes. Keep investing in high-quality stocks and don't get dissuaded by short-term "bumps" along the way.
  6. Look for rising income opportunities. To boost your investment income, consider buying stocks that have historically increased their dividend payouts from year to year. Dividends may now be even more attractive if you live in the US, because they are taxed at a maximum rate of just 15 percent. (Keep in mind, though, that stocks are not fixed-income investments and may not pay dividends.)
  7. Don't forget "growth-and-income." Many investors are attracted to the potentially high returns of "growth" and "aggressive growth" stocks. But there's almost certainly a place in your portfolio for good, solid "growth-and-income" investments, which provide opportunities for capital appreciation and current income.
  8. Limit exposure to risky investments. Be cautious about investing in emerging markets, "junk" bonds, technology stocks, and commodities such as oil and gold. Before adding these volatile investments to your portfolio, do your homework and read every investment book or article you can lay your hands on. Consult a fee-based financial adviser, one who comes highly recommended.
  9. Build a "bond ladder." Building a "ladder" consists of owning bonds with various maturities. They will pay off in a "staggered" ("laddered") schedule and thereby help to protect you in all interest-rate environments. When market rates are low, you'll have your high-rate, long-term bonds working for you. If rates rise, you can reinvest the proceeds of your short-term bonds into new bonds issued at the higher rates.
  10. Reinvest, reinvest, reinvest. If your investments generate dividends or interest that you don't need to meet monthly expenses, consider reinvesting that income to put the power of compounding to work.
  11. Follow principles, not predictions. No one can predict with any accuracy what future years will bring to the financial markets. So stick with the investment principles that never go out of fashion, such as diversification, Pick Stocks and Other Investments With Fundamental Analysis, and maintaining a long-term perspective. If you formulated a good investment plan to begin with, there's no reason to abandon it no matter what the markets do in the short term.



Tips

  • Invest in those vehicles that will let you sleep at night.
  • Remember that more risk does not always mean more return. It generally will mean more volatility.
  • Don't try to "time" an investment. Over the years the US stock market has gone up considerably. Many investors, however, barely make a profit because they get in and out of the market at the wrong times and miss out on some of the big gains. The biggest gains tend to be fast and unanticipated. It's best, then, to invest in good companies and stick with them.
  • Be careful about those from whom you seek advice. Everyone has an opinion, but not everyone willing to talk to you about your money is well-informed (or has your best interests in mind).
  • Develop a comprehensive plan with the help of a professional. Over time s/he will be your greatest ally. If not, find one who is. Make sure he or she is fee-based, not commission-based.

Warnings

  • You should make sure that you have emergency funds covered first, then short-term needs (1 - 2 years) before starting a long-term investment program. You want to leave your long-term money invested unless you're out of other options for meeting expenses.
  • Investing is not guaranteed and always involves some risk of losing principal. Find investments that are of good quality and meet your goals and risk tolerance.

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Sources and Citations

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