Education
The Power of Portfolio Diversification: A Key to Financial Success
Education
July 28, 2023
It's the classic piece of financial advice we all know: don't put all your eggs in one basket.
But why is diversification so important, and how can you make it work for you?
Diversification is an essential strategy for managing financial risk. The idea is simple - spread your investments across various types of assets, sectors, and geographical regions. If one part of your portfolio takes a hit, other parts can help offset the loss.
By diversifying, you reduce the likelihood of losing a large portion of your portfolio all at once, helping you to better navigate the inevitable market ebbs and flows. This strategy becomes especially important if you are heavily invested in a specific industry or company.
Key points:
Diversification helps manage financial risk by spreading your investments across different assets and sectors. This can buffer against market dips and potentially boost returns.
Alternative investments, like real estate or private equity, offer unique return, risk, and liquidity profiles, and can help enhance your portfolio diversification. They've traditionally been the playground of the ultra-wealthy, but not anymore.
Arta makes diversification easy and accessible by providing AI-managed portfolios (AMPs) and unlocking alternative investments.
The importance of diversification
If a large part of your wealth is tied up in one particular sector or company, relying solely on these investments can be risky. That's where diversification comes in.
Spreading your investments offers a variety of benefits, including:
Reducing overall portfolio risk
Hedging against market volatility
Potentially generating higher returns
The advantages extend even further:
By investing in easily liquidated assets like AMPs, you can quickly access funds for significant expenses like buying a house.
Putting money into assets that could serve as future loan collateral, such as real estate, can provide a valuable financing source.
By exploring structured products, such as options, you can create an income stream while hedging against volatility.
How can you diversify your portfolio?
You can decrease the risk associated with a concentrated portfolio by investing in other sectors and asset classes. To achieve a diversified portfolio, look for assets that have low or negative correlations with each other - meaning if one dips, the other tends to rise.
What does a diversified portfolio look like?
There's no one-size-fits-all answer to the ideal allocation for a well-diversified portfolio. Instead, it depends on several factors, including your investment goals, risk tolerance, and investment timeline. However, a common strategy is to spread your investments across a mix of different asset classes, such as stocks, treasuries/bonds, and alternative investments, like real estate, private credit, or private equity.
The proportion of each asset class in your portfolio will depend on your individual circumstances and goals. Still, a general rule of thumb is to have a higher allocation in stocks when you have a longer investment timeline and a higher risk tolerance and then a higher portion in bonds when you have a shorter timeline and a lower risk tolerance.
Ultimately, the goal in building a diversified portfolio is to ensure that your investments are spread out enough that you're not overly exposed to any one asset class or sector.
Ways to diversify your portfolio
Alternative investments
Alternative investments, or “alts,” are financial assets outside traditional public market stocks, bonds, or cash offerings.
These investments tend to have different return, risk, and liquidity attributes than traditional investments and are often included in a comprehensive investment strategy. Investing in private markets has typically been a strategy of the ultra-wealthy since alts tend to have very high investment minimums. Real estate, private equity, private credit, and venture capital are examples of alternative investments.
How to diversify into private markets alternatives:
Arta offers access to alternative investment opportunities that have traditionally been out of reach for most investors. By establishing direct relationships with fund managers and aggregating smaller investments, Arta opens up new possibilities for its members.
US Treasuries
US Treasuries are commonly regarded as some of the safest investment options available, as the US government fully backs them. US Treasuries can help act as a ‘stabilizing’ effect on a stock-heavy portfolio.
How to diversify into US Treasuries:
High-Yield Cash Reserve are a short-to-medium-term, relatively low-risk strategy for those seeking a stable investment with the opportunity to earn income from interest payments and enjoy potential tax benefits.
The High-Yield Cash Reserve invests in lower-risk ETFs that hold a basket of various U.S. Treasuries.
Public market securities
If your portfolio is heavily weighted in a few individual company stocks, a goal could be to find an automated solution that gets you exposure in the broader stock market, while not ‘giving up’ performance.
How to diversify your public market securities:
AI-Managed Portfolios (AMPs) are designed to manage risk systematically and reduce portfolio dips during market volatility, aiming for better long-term performance.
Specifically, Grow AMPs are crafted as a longer-term, stock-centric investment solution for those looking to maximize their growth potential. Combining the ease of an index fund with the scientific rigor and market expertise of a quant hedge fund, Grow AMPs execute sophisticated trading strategies on your behalf that actively manage the tradeoffs between risk and return.
AMPs build on the relationship between uncorrelated risks and diversification, helping to bring the modern portfolio theory principles of the late Nobel Laureate Harry Markowitz and many others to every Arta member’s public markets investments.
Systematically selling to reduce a concentrated position
Is a significant share of your wealth tied up in one or a select few individual stocks? Maybe you've found yourself in this position through stock awards from an employee incentive plan. Or a single stock pick from your portfolio performed incredibly well, and its increased value now dominates your holdings. That's an enviable “problem” to have, right? It sure is, but now you may want to diversify this position. So, how do you go about it systematically and with disciplined planning?
How to systematically sell an individual stock to use those proceeds to diversify
Arta developed Income Stream Options to help members who want to systematically sell a stock with potential growth. Rather than monitor the market yourself, simply communicate your desired selling price to Arta. We’ll handle the rest, selling an option to a willing buyer at or above your predetermined price in the future. And as a bonus, you’ll earn a bit of income while you wait for the stock to reach the target price.
You can learn more about Income Stream Options in the Level-Up section of the Arta app.
The Arta approach
At Arta, we champion diversification as a pathway to financial success. Diversification helps to buffer against market volatility and opens the door to potentially higher returns. Yet, we also understand that achieving an optimally diversified portfolio requires time, knowledge, and access to a wide range of investment opportunities, especially in alternative markets. That’s why we’re here to help. We don't just advocate for diversification; we make it achievable.
With Arta, you can enjoy stress-free, streamlined investing similar to the methods used by the ultra-wealthy. Simply open your Arta app and check out all the ways we can help you diversify your portfolio.
Become an Arta member today.