Portfolio theory, as used by most financial planners, recommends that you diversify with a balance of stocks and bonds and cash that's suitable to your risk tolerance.
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My view is that one should diversify broadly across different fund investments. However, it's tough for investors to try to pick the appropriate risk level that they should manage their funds at. Having a personal adviser would be helpful.
If the investor doesn't have enough time and skill to investigate individual stocks or enough money to diversify a portfolio, the right thing to do is to invest in exchange-traded funds that give you exposure to asset classes. It does make sense for the individual investor to think in terms of holding individual asset classes.
For investors who do want to speculate in high-yield bonds, one alternative may be a junk bond mutual fund, which can offer investors the relative safety of diversification.
I personally have said many times I'd be a hundred percent in equities. That fits my risk profile and my views of the world, though obviously it's not appropriate for everyone. Most investors need a more diversified portfolio.
The beauty of diversification is it's about as close as you can get to a free lunch in investing.
Diversifying sufficiently among uncorrelated risks can reduce portfolio risk toward zero. But financial engineers should know that's not true of a portfolio of correlated risks.
Having different types of stocks in your portfolio can enhance returns.
Owning a variety of asset classes means that some part of your portfolio will be doing well when the cyclical turmoil arises. A broadly diversified portfolio includes large capitalization stocks, small cap, emerging markets, fixed income, real estate and commodities.
I think that the first thing is you should have a strategic asset allocation mix that assumes that you don't know what the future is going to hold.
Always keep your portfolio and your risk at your own individual comfortable sleeping point.
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