Building a Diversified Portfolio: A Step-by-Step Guide for Beginners 

The word “investing” evokes a great sense of opportunity, but with it can come an equally great deal of anxiety. Picking the right investments, controlling risk, and managing emotions are all easier said than done. However, with the right practice, even someone with no investing experience can set themselves up for a great future outcome. Let’s look at 9 steps even a beginner can take to build a diversified investment portfolio.  

Set Your Timeframe 

Time is without a doubt the number one most important element when it comes to determining the proper investment allocation. There is an old saying that goes, “time in the market is more important than timing the market” and it is completely true. While there are plenty of bad investments out there, a well-built portfolio has an overwhelming chance of achieving very desirable long term returns.  

In contrast, someone with a short time frame should shy away from taking on the same amount of risk as someone who is investing for the long term. Check out our post on the 4 Key Asset Buckets in Retirement for an in depth summary of how to arrange your assets based on your timeframe.   

How to Diversify 

Diversification may seem like an easy concept that is fairly straightforward, but it can be easier said than done. There are two criteria for evaluating diversification – proper and effective. When looking at the alleged impact of a portfolio, it must meet both of these factors to work in the investor’s favor. If only one of them is missing, the portfolio will not meet it’s stated goals. 

Proper diversification involves investing into different asset types and asset classes. Asset types are the largest pieces of an investment portfolio and they include stocks, bonds, cash, commodities, and real estate. If you’ve ever been convinced by any television personality trying to tell you that you’re completely diversified with 5-10 stocks for your entire investment portfolio, they’re wrong. You may be starting to touch the surface of diversifying your equity holdings, but that’s like cutting one piece of the pie into even smaller pieces. You still have a big part of the pie left.    

Effective diversification involves making sure where you’re putting your money(hopefully across the areas we mentioned above) into a strategy that’s actually working. The effectiveness of any strategy is only really known once it’s been implemented. In the case of diversification, there are many very solid strategies that don’t always work 100% of the time. For example, in 2022 bonds sold off at one of the highest rates in decades, at the same time that equities were declining. This high correlation temporarily undermined the value of a stock/bond portfolio and resulted in a less-than-effective diversification strategy.    

Investing ≠ Trading  

As tempting as it can be to jump on trading bandwagon, investing and trading should be viewed differently both in concept and in practice. Another way to look at it is investing is a crockpot, and trading is a microwave. Both have very different uses and applications. While trading can yield great short term returns, it is very uncommon to see someone succeed at trading over the same time frame of someone who is investing. Conversely, the opposite is true for investing. While there may be periods of volatility and even negative returns in the short term, a recent study by BlackRock showed that 94.8% of people made money in any 10 year time period between 1970 and 2020.   

Invest the Same Amount Every Time 

For someone who is still in the accumulation phase of life, discipline almost always outweighs performance. While great performance can certainly help to speed up the growth process, the power of putting aside money consistently over time can’t be overstated. This not only leads to a better average cost due to Dollar Cost Averaging, it also trains us to master the psychology of delaying gratification. By putting this money away for a designated purpose and goal, we are subconsciously prioritizing the funding of our future goals and dreams.  

Monitor Internal Fees  

We’ve all heard it to some extent or another – control what you can control. While we can’t control the majority of things in investing, we can control(to a large extent) the internal fees we pay. Internal fees are those charged by an investment company to run their particular Mutual Fund, ETF, or SMA. This ratio is known as the expense ratio. For instance, someone who is invested in a generic target date retirement fund through their 401k might be better finding a few  lower cost Mutual Funds in their fund lineup. An even better option to this would be if the 401k offered a brokerage window with low cost ETFs. Over time, these internal fee savings can bolster the overall portfolio return.

Rebalance at the Same Interval  

Rebalancing is the act of returning a portfolio back to it’s intended allocation. This becomes necessary over time due to the performance of the individual investments in the portfolio. For instance, someone with a portfolio of 60% stocks/40% bonds might see their portfolio shift to a 70% stock/30% bonds mix as stocks outperform bonds over time.

When deciding when to rebalance, it is best to take the Goldilocks approach – not too much, not too little, but just right. Typically, it is best to rebalance a portfolio no sooner than quarterly and no longer than annually, with semi-annually being about the right timeframe. One caveat to add to this – if your investment custodian charges trade fees, it is usually better to rebalance less often. If there are no trade fees involved, a more frequent rebalance schedule is appropriate.

Keep Taxes in Mind

Depending on the type of account you’re investing in, taxes can weigh on your portfolio return if not managed properly. For instance, if you are investing in a taxable account such as a joint account or revocable trust, dividends, interest, and capital gains will be assessed as they are incurred. However, if you are investing in a qualified account such as an IRA, Roth IRA, or 401k, the only taxes paid will be either upon distribution or not at all. 

Boring Should be the Norm 

Our final two steps involve more general wisdom and common sense than practical strategies. As I mentioned with trading above, a good investment account can seem pretty boring, right up there with watching your new, fancy paint job dry. However, if you see this happening regularly, you can view this as confirmation that you are on the right track. It is the slow, steady growth and compounding over time that gets you to the realization of your financial goals.

Follow Trustworthy Sources

I hate to break the news, but a financial influencer on social media doesn’t have your best interests in mind. Having a knowledgeable individual in your corner who has been there and done that can help to keep you on the right track and on the road to your goals. The simple fact of someone who knows you and your situation can be the difference between making a good financial decision or not. If you don’t have anyone you’re currently working with to help provide this perspective, schedule a call with us today to learn more about how we can help.

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This content is developed from sources believed to be providing accurate information. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Evergreen Financial Group, LLC is a registered investment advisor offering advisory services in Montana and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. This communication is for informational purposes only and is not intended as tax, accounting or legal advice, as an offer or solicitation of an offer to buy or sell, or as an endorsement of any company, security, fund, or other securities or non-securities offering. This communication should not be relied upon as the sole factor in an investment making decision. All opinions and estimates constitute Evergreen Financial Group’s judgement as of the date of this communication and are subject to change without notice. Evergreen Financial Group does not warrant that the information will be free from error. The information should not be relied upon for purposes of transacting securities or other investments. Your use of the information is at your sole risk.