How to build a diversified portfolio? In the ever-evolving landscape of investing, a diversified portfolio has become more crucial. Traditional investment avenues continue to have their place. But, exploring new-age alternatives can offer a fresh perspective and potential for higher returns. This blog will guide you through 11 innovative ways to build a diversified portfolio.
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A diversified portfolio refers to an investment strategy in which an individual or an entity allocates their funds across a variety of different assets and asset classes. The goal of diversification is to minimize risk by spreading investments across various types of securities, industries, sectors, and geographic regions.
A diversified portfolio example or example of diversified portfolio could consist of a mix of 60% stocks, 30% bonds, and 10% real estate investment trusts (REITs). This allocation spreads risk across different asset classes, aiming to balance potential returns and minimize exposure to market fluctuations. Within each asset class, further diversification can occur through investments in various industries and sectors.
Below is the risk and return trade-off With and Without Alternatives
(Data as of Jan 1, 1990, to Dec 31, 2021)
Source: Bloomberg, Morgan Stanley Wealth Management GIC, Private Equity Index data: The Cambridge Associates
When it comes to portfolio diversification, a prudent portfolio manager takes into account three key strategies, each contributing to a well-rounded investment approach.
Diversification Within Individual Assets
The initial approach involves spreading investments across a spectrum of assets within a particular asset class. This can involve straightforward actions such as investing in market indices like the S&P 500 or the Russell 2000. The purpose here is to ensure a diverse representation of high- and low-risk stocks across various industries in your portfolio. Alternatively, it might entail purposeful investment in industries that exhibit a symbiotic relationship with each other.
Expanding Horizons with International Markets
The second strategy advocates for venturing beyond domestic borders. By delving into international markets, investors can mitigate the risk of underperformance in their home country's market and strike a balance within their portfolio. However, it's important to recognize that investing in foreign markets introduces distinct rules, regulations, and processes that may differ from those in your own country.
Embracing Diversification Across Asset Classes
The third strategic avenue emphasizes diversification through investment across various asset classes. These encompass conventional investment vehicles like stocks, bonds, and cash, which are traded in the public market. Alongside these, there exists an array of alternative investments that primarily operate in the private market and are subject to limited regulation. Alternative investments possess the potential to significantly enrich portfolios due to their compatibility with traditional investments.
Impressive Returns
Consistently, alternative investments have displayed a track record of delivering noteworthy returns. As of 2023, private equity funds have reported average annual returns ranging between 15% to 20%, eclipsing the performance of conventional asset classes. The triumph of venture capital investments is particularly remarkable, underscored by the striking milestone of total global funding reaching a formidable $368 billion this year.
Diversification Potential
Investors are acutely attuned to the imperative of diversifying their investment portfolios. The projected outlook for 2023 anticipates the global market for alternative investments to surmount the $14 trillion mark, unveiling a substantial array of choices extending beyond the traditional spheres of stocks and bonds. The alternative asset segment of real estate, held in high regard, has demonstrated commendable expansion, culminating in its global market valuation reaching an impressive $9.6 trillion in this year.
1. Real Estate Structured Debt
Structured debt supported by real estate pertains to investment vehicles that present fixed-income possibilities by leveraging real estate assets as collateral. These investment instruments grant investors access to the real estate market devoid of the necessity for direct ownership or operational involvement. Investments backed by real estate can yield appealing returns through interest disbursements and conceivable capital appreciation. Nevertheless, it's essential to acknowledge that returns might oscillate contingent on market circumstances and the underlying asset's performance. Broadly speaking, these investments, facilitated through alternative avenues, carry the potential to generate returns spanning from 12 percent to 18 percent.
2. Cryptocurrencies
Cryptocurrencies have taken the financial world by storm, presenting a high-risk, high-reward opportunity. Bitcoin, Ethereum, and other cryptocurrencies have shown impressive growth over the past decade. Despite their volatility, they have become appealing to investors looking to diversify beyond traditional assets. Experiencing a surge, the collective market capitalization of cryptocurrencies has exceeded $2.5 trillion, captivating the interest of both individual and institutional investors in pursuit of substantial growth prospects.
3. Renewable Energy Ventures
The push for clean energy has created a lucrative investment opportunity in renewable energy projects. From solar and wind farms to energy storage solutions, sustainable ventures not only contribute to a greener future but can also yield substantial returns as the world shifts towards cleaner alternatives.
The recent publication from the Centre for Climate Finance at Imperial College Business School and the International Energy Agency reveals that renewable power has achieved notably superior total returns in the past decade, reaching 422.7%, compared to 59% for fossil fuels. This signifies a return over seven times greater than that of fossil fuels.
4. Real Estate Crowdfunding
Real estate has always been a solid investment option, but the high barriers to entry can be daunting. But via real estate crowdfunding, you can invest smaller amounts alongside other investors to fund larger property deals. This democratized approach allows you to diversify your portfolio with real estate assets without the need for substantial upfront capital. Forecasts for the global crowdfunding sector for 2023 paint a picture of surging growth, poised to ascend beyond the $400 billion threshold.
5. Artificial Intelligence and Tech Stocks
The technological revolution is far from over, and investing in AI and tech stocks offers a chance to ride this wave. Companies involved in artificial intelligence, automation, and innovation are shaping the future. As these technologies continue to advance, the potential for growth remains high, making tech stocks an attractive addition to your portfolio. Over the course of the last decade, the technology sector has produced an average annual return of approximately 13%, in contrast to slightly above 7% for the S&P 500. Looking back two decades, tech stocks have yielded an annualized return of 16%, surpassing the broader market's return by more than two-fold.
6. Peer-to-Peer Lending
Peer-to-peer lending platforms offer an alternative avenue outside of traditional banking systems, enabling individuals to directly lend funds to borrowers. This method presents the opportunity for elevated interest rates in contrast to typical savings accounts. Yet, it's crucial to conduct comprehensive platform research and grasp the inherent risks before embarking on this journey. A meticulously constructed loan portfolio holds the potential to yield an annual return of 10% or even higher.
7. Fine Wine
Some of the most exceptional vintage wines globally maintain a flourishing presence in the realm of fine wine, often accompanied by substantial price points. Demonstrating annual returns of 11.6%, the fine wine sector has surpassed the performance of the S&P 500 index throughout the preceding three decades.
8. Commodities
Commodities such as gold, silver, and oil have historically served as hedges against economic uncertainty. These tangible assets can safeguard during market downturns, making them a valuable diversification tool. Investing in commodities can be achieved through various financial instruments, such as exchange-traded funds (ETFs) or commodity futures.
9. Farmland Investing
Investing in farmland presents a unique and distinctive avenue within the realm of alternative investments. This choice derives its allure from the projected increase in both food demand and the cultivation areas responsible for its production. The year 2018 witnessed the pinnacle of this trend, with the collective market value of farmland and associated structures in the United States surging to nearly $2.7 trillion. Opting to diversify one's holdings through farmland investment emerges as a prudent strategy, particularly when collaborating with an entity capable of managing the administrative intricacies inherent in adding farmland to your investment portfolio. Additionally, the potential benefits extend to crops, which can capitalize on inflation and market volatility. Moreover, the value of farmland remains insulated from fluctuations in the broader market.
10. Private Equity
In 2023, the demand for private equity investments remains robust. Delivering an average annual return of up to 15%, private equity grants investors entry into companies not publicly traded, fostering the possibility of significant capital growth.
11. Gold & Precious Metals
Among the most renowned alternatives, gold and silver tend to stand out. Both possess a robust capability to retain their value and are disconnected from the fluctuations of stocks. Consequently, during periods of erratic or sluggish stock performance, they offer significant potential for portfolio diversification. Interestingly, the ebb and flow of the markets exhibit an inverse relationship with the trajectory of gold. Typically, when markets exhibit weakness, the price of gold tends to ascend. For example, during the interval spanning December 2007 to February 2009, the S&P 500 witnessed a fifty percent decline in its value, while concurrently, the value of gold surged by 14%. This characteristic makes gold an exceptional asset to include in one's portfolio, irrespective of the presence or absence of financial upheaval.
Diversifying your investment portfolio in the US involves exploring innovative avenues beyond traditional options. Cryptocurrencies, renewable energy ventures, real estate crowdfunding, tech stocks, peer-to-peer lending, impact investing, biotech, commodities, water, and space exploration are all new-age alternatives that can enhance your portfolio's resilience and potential for growth.
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Q1. What is a diversified portfolio?
A. A diversified portfolio refers to an investment strategy in which an individual or an entity allocates their funds across a variety of different assets and asset classes. The goal of diversification is to minimize risk by spreading investments across various types of securities, industries, sectors, and geographic regions.
Q2. How do I diversify my portfolio?
A. You can diversify your portfolio by adding the following alternative investments
Q3. How to build a diversified portfolio?
A. You can build a diversified portfolio by adding alternative investments like real estate, private equity, commodities, and cryptocurrencies.
Q4. What is an example of a diversified portfolio?
A. An example of a diversified portfolio could consist of a mix of 60% stocks, 30% bonds, and 10% real estate investment trusts (REITs). This allocation spreads risk across different asset classes, aiming to balance potential returns and minimize exposure to market fluctuations. Within each asset class, further diversification can occur through investments in various industries and sectors.
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