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Family Business Center of Pioneer Valley

Why Diversification Matters

By Allison Standish-Plimpton, VP & Senior Relationship Manager, Business Banking, KeyBank

SUMMARY: Most people today can expect to live at least 30 years in retirement. Diversifying money across a range of investments helps protect our portfolios from events we cannot foresee, it reduces the risk of losing on a sole investment and it helps to maximize the odds that investors will reach their financial goals. This article explains what diversification is, as well as looks at the benefits of diversifying your portfolio. It also explains the various investment options available to you to select from when diversifying your portfolio.


Diversification is simply the “act of introducing variety.” Diversifying your investment portfolio does just that, adding a variety of investments that will allow you to take a little risk with some investments while playing it safe with others.


In the short-term, diversified investments do not yield big results. Nor are they designed to net you the largest possible return on investment possible. Instead, being diversified is about having a variety of investments that balance each other out over the long term to yield positive, safer returns. For example, investing heavily in one sector of the economy or a hot business may yield great returns if you time it right, but if that market stagnates or declines, your exposure to risk and the potential to lose big money is both real and likely. Diversification protects you against such market volatility.


The benefits of diversifying your portfolio
With any investment, there are risks, including loss of money and price volatility. A diversified portfolio is not immune to these exposures. However, the benefits are many. A diversified portfolio will:

  • Reduce the overall risk on your investment.
  • Further reduce risk when the diversification is among assets with low correlations to one another.
  • Limit losses.
  • Account for the uncertainty of knowing which investments or asset classes will perform well or poorly or when.
  • Protect your portfolio from events that you cannot foresee, such as a business bankruptcy.
  • Maximize the odds that you will reach your financial goals when combined with a solid financial plan.

The goal of a diversified portfolio is to select enough investment categories to keep the option of a lower return minimal—to better maintain your investment in hopes to see larger growth and maximized returns.


Your allocation of investments should be largely based off of your financial plan. In other words, it should take into account your cash flow needs, investment goals, risk tolerance and when you think you may need to access the funds in the future.
Also, as your financial needs change as life events happen, you will likely review your financial plan and reset goals. When this happens, you should reevaluate your investment portfolio and account for these changes.


A deeper understanding of diversification
An investment that performs well one month or year may not perform as well the next. A diversified portfolio distributes investments across several different investment categories such as stocks, bonds, certificates of deposits (CDs), money market funds, mutual funds, exchange traded funds (EFTs), real estate and/or other asset types so that your money isn’t all in one place. This is a strategy to combine a variety of assets to reduce your overall risk.


How you diversify your portfolio should account for a variety of factors, such as your age, income streams, and risk tolerance. Diversification, while a sound strategy for all, is not a one-size-fits-all, and spending the time to determine which ratio is right for you will pay big in the future. And while the perfect balance is hard to achieve, a diversified portfolio coordinates investments that fluctuate in value at different times so that the overall investment can increase in value.


As an investor, it’s natural to want to maximize the return on your investment. However, you should avoid succumbing to the temptation to invest all your money in the hottest stock available. Sure, the reward could be huge, but it isn’t a sound approach because you are just as likely to lose everything as you are to hit the investment lottery. If you do want to be more aggressive and have a higher tolerance for risk, the way to do it is to pair “risky,” high-return investments with “safer” investments that deliver lower, more predictable returns. This will help create a balanced portfolio that performs more steadily.


Just as you should evaluate your financial plan regularly, you should review your portfolio regularly, especially as you get older. What works when you are young and graduating college may not work as well when you start a family or change jobs. And as retirement nears, it's important to shift money into asset classes that may not be as risky. The key is to find the right level of diversification for you. A trusted financial advisor can help you create and adjust your portfolio as your needs change.

About the author:
Allison Standish Plimpton is Vice President and Senior Relationship Manager, Business Banking at KeyBank.  She works across the KeyBank franchise to provide financial services to business clients, including investment strategies. For more information contact Allison at 860-645-2583 or Allison_Standish_Plimpton@keybank.com

This material is presented for informational purposes only and should not be construed as individual tax or financial advice. Please consult with legal, tax and/or financial advisors. KeyBank does not provide legal advice.
©2017 KeyCorp. KeyBank is Member FDIC. 170130-187266
 

©2017 KeyCorp. KeyBank is Member FDIC. 170130-187266

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