3 Ways to Diversify Index Funds

by Andrew McGuinness     Jul 16, 2019

An important part of trading 101 includes developing a portfolio that is considerably diversified. Diversifying a portfolio involves investing in plenty of different types of companies as well as asset types. This makes it easier for you to sustain the blows of some risky investments, because any losses you suffer will be balanced off by the profits you gain from other investments within your portfolio.

A good thing about diversifying with index funds is the fact that index funds are actually very cost-efficient. This means investors are able to more easily pursue a highly diversified, expansive portfolio while using less of their capital. Here are three ways to diversify an investment in index funds.

1. Funds rather than stocks

Investing in stocks is time-consuming and difficult if not impossible. There are thousands of individual stocks on the market and to diversify your portfolio by choosing them by hand, one by one, would be a pointlessly long task. Instead, there is the possibility to choose from different funds which exposes you to countless stocks that you may profit from.

For example, exchange-traded funds and mutual funds adhere to an index and are pre-diversified, holding a substantial amount of different stocks. Also, the more money you put into your investment in one of these funds, the more is distributed among the exceedingly valuable stocks within the index.

2. Probability of profit

While stocks are reasonably volatile and likely to cause an investor to suffer losses at virtually any given moment, funds allow for safer, more stable investments. Index funds are more likely to eventually get back up after falling as well. If a stock were to fail, on the other hand, the chances of your investment raising to where it once was are slim to none.

Proof of the fact that index funds can’t be knocked down is an index in the S&P 500. An index within S&P 500 was found to have lost its investors 37% of their capital in 2008. A decade later, in January 2018, this same index actually increased an astounding 350%.

Getting back up after a fall is not guaranteed with any investment, but index funds have proved it to be more possible than that of a failing stock. Failing stocks have a tendency to stay down, while index funds allow investors to hold on to an ounce of hope due to the fact index fund losses have often been recovered before and may be recovered again.

This is an occurrence that needs time, however, as illustrated in the example above. If you don’t have a decade to spare in order to wait for your investment to recover its once healthier state, if you don’t want to be patient for an event that may not occur at all, it would be best to simply move your funds elsewhere.

3. Fields or sectors to focus on

Sectors you can invest in within index funds include oil, finance, technology, and consumer goods, just to name the most popular. You may choose to either diversify your investments within one sector or a couple.

If you are a novice investor, it would be best to start with more of a narrow portfolio, sticking to one sector that you are able to research and get to know fairly well. If, however, you don’t feel very strongly about an investment in any single sector in particular, you might get the most out of trying your luck in a few, since one is bound to do well.

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