Diversification helps you manage risk by ensuring you have a variety of different investments within your portfolio. That, in turn, can improve your overall performance. For most individual investors, a solid diversification strategy means holding different types of stock funds, bond funds and cash — and just investing in your 401(k) might not cut it. Indeed, as this Wall Street Journal piece notes, you’ll likely need a lot more stocks than you think for proper diversification; however, many workplace retirement plans offer limited options. Here’s what you need to know to create a solid diversification strategy.
Understand different types of funds
Funds are divided into several categories according to the size of the companies the fund buys and the investing approach. In terms of size, funds are categorized according to the market capitalization, or “market cap,” in trader lingo, which is the sum of the company’s share price multiplied by the number of its publicly traded shares. Large-cap funds invest in shares of well-established companies with more than $10 billion in market capitalization, also called “blue chip” companies. Small-cap firms are worth between $300 million and $2 billion, while medium caps occupy the space between $2 billion and $10 billion.
The styles of funds available include:
- Growth funds: Managers look for companies they see as successful and growing, providing a steady stream of price gains, plus dividends in many cases.
- Value funds: Include stocks of companies that are trading at prices lower than what the bargain-hunting fund managers think those companies really are worth.
- Blended funds: A mix of growth and value stocks, often found in funds that invest in large market indexes or some combination of benchmarks.
- International funds: Shares of companies that are headquartered and do business outside of the United States. Some investors argue that buying most large-cap funds already provides international exposure, since most of those firms operate globally. Some international funds focus on particular regions of the world, or on emerging markets or other categories of overseas companies.
- Sector funds: Invest in stocks of companies that operate in a particular industry, such as transportation, healthcare or banking.
- Index funds: These funds follow established market indexes, such as the Dow Jones Transportation Index, the S&P 500 and the Dow Jones Index. . Many new ETFs focus on indexes of their own devising, such as stocks of pet-care related companies.
- Real estate funds: These invest in either corporate or residential real estate, often real estate investment trusts (REITs) or companies involved in home or office construction. Real estate has different risk and reward factors than stocks, making …….