What Is Asset Diversification?
Asset diversification is investing money into different investment categories. Some of the different categories include stocks, bonds and mutual funds. Asset diversification varies from person to person. The two primary considerations an individual should consider when diversifying assets is risk tolerance and the time frame he has to invest the money.
Diversifying assets starts with a financial plan for the targeted investment account. Each investment account has its own purpose for the account holder. For example, it may be a retirement account or it may be an investment account that allows the account holder to fund a child’s college education at some point in the future.
Part of the asset diversification plan is to assess the risk tolerance of the account holder. A conservative investor will want to stick with low to medium risk investments. A person who has a high risk tolerance, on the other hand, may have an investment portfolio that is more aggressive with higher risk types of investments. No matter which type of investor the individual is, the portfolio needs to be balanced with a percentage assigned to each type of investment in the portfolio that is calculated to achieve the goals for the account.
The second primary factor when dealing with asset diversification is the time frame the account holder has to invest the money. When an investor has a short time frame to earn the return on the investment that he needs, he may need to invest in more aggressive and riskier investments. The longer the investment time frame that the investor has, the more conservative he can be in choosing the asset diversification in his portfolio.
Asset diversification also changes over time. Life changes, such as marriage, divorce or the birth of a child are some of the circumstances when asset allocation needs to be re-evaluated. As the time when the investor needs to use the money from the account draws near, the asset diversification plan may also likely need to be changed.
For example, when a college graduate gets her first job and an employer-sponsored retirement account, the asset allocation can be very aggressive because the employee has about 30 years or longer before she will need to access the money. When an employee is 50 years old, she will most likely change her asset allocation to a more conservative level to preserve the money in the account and not risk losing it all right before she heads into her retirement years.
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