Investing for Beginners: 3 Diversification Mistakes to Avoid
Every adviser talks about diversification – basically having your investments spread across a variety of asset classes, such as large companies, small companies, international, etc. The weightings assigned to each asset class mainly depends on your time horizon, goals, and risk tolerance.
The idea is that by spreading out your investments across several industries, you won’t be in too much trouble if one of them suddenly tanks. While diversification sounds simple on the surface, it can be tough to know where and when to invest your hard-earned money.
3 Diversification Mistakes that Cause Dysfunction
When it comes to diversification, there are some mistakes you’ll want to avoid to keep your finances in tip-top shape.
1. Not being transparent about your assets
One of the largest mistakes investors make is thinking they are diversifying their portfolio by diversifying the advisers or companies managing their money. Having your assets spread across companies may seem diversified but actually can be destructive to your goals.
When one person isn’t seeing the whole picture, advice becomes centralized on what they know. The more spread out you are, the narrower the scope of the advice. That’s why it’s important to be open with your advisers about what you have, and where.
2. Putting all your eggs in one basket
The second mistake is concentrating on one asset, gold comes to mind. Whenever anyone wants “to sell everything and buy gold.” it usually sends chills down my spine. The whole point of diversifying is making sure you are not relying on one asset to fund your goals.
Every asset class has bad years and good years. No one can accurately predict the ups and downs. When everyone invests in the same asset a bubble can occur when emotion trumps fundamentals. Remember when people say real estate “always goes up”? Or technology can only go higher? Beware of concentrating money in only one area.
3. Ignoring your tax options
The last diversification issue is ignoring your taxes. Not only do you have options on where and how you are taxed, most people forget to think about it as they plan for retirement. Tax-deferred and tax-free can be the difference in a few hundred dollars a month in income down the road. Although the tax situation is still uncertain right now, it’s not a bad idea to explore Roth IRA‘s and whether you should hold growth stocks in a taxable account or not.
Remember an IRA is great for tax deferral but eventually you will pay income tax on every dollar coming out when you begin receiving distributions.
Diversification is only one part of the big picture that is your investment portfolio. Talk to an advisor to keep your money goals on track.
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