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5 Potential Benefits of Diversification

Diversification can provide potential advantages that go beyond overall returns. But first, you need to know what you're trying to achieve.

What are you trying to achieve with your investments? The number one answer is usually return on those investments, but a diversified portfolio may provide additional benefits as well.

As with most investment decisions, the right choice for you depends on your overall financial goals and factors such as your level of risk tolerance. With that in mind, here are five types of potential additional rewards to consider when you’re looking to diversify your portfolio — and how to discuss them with your relationship manager.

Seeking income

1. Seeking income. Bond yields have been relatively low for much of this market cycle, so investors pursuing income may consider utilizing other investments such as dividend-paying stocks, real estate investment trusts (REITs), or alternative investments in their portfolios. That said, bonds are still worth considering as dividends can be reduced or eliminated at any time while bond interest payments are generally more reliable.

What to discuss with your relationship manager: How will your income-generation strategy impact your retirement and legacy planning? Be sure to talk about the impact of market volatility and strategies that seek to preserve your assets during times of increased market fluctuations.

Managing risk

2. Managing risk. Diversification may help you manage your investments’ unsystematic risk. You may also want to consider pursuing downside protection through the use of a hedging strategy. With downside protection strategies, overall portfolio returns may be reduced.

What to discuss with your relationship manager: Ask if a downside protection strategy might be a smart strategy to help you maintain an appropriate level of risk based on your investment objectives.

liquidity

3. Liquidity. Most stocks and bonds are liquid assets, but have market risk. Many investors use these types of assets to save for such major expenses such as college tuition or a home purchase. Cash alternatives like money market funds can be used for an emergency fund when an unexpected need for cash arises. Relatively liquid assets typically have lower return potential than illiquid assets.

What to discuss with your relationship manager: Talk through any major expenses you can foresee in the near future and discuss whether your asset mix is right for your situation.

Managing tax liability

4. Managing tax liability. Certain assets, such as municipal bonds, may offer tax-advantaged income at the federal and sometimes state levels. Income from municipal securities is generally free from federal taxes and state taxes for residents of the issuing state. While the interest income is tax-free, capital gains, if any, will be subject to taxes. Income for some investors may be subject to the federal Alternative Minimum Tax (AMT).

What to discuss with your relationship manager: Ask if your portfolio is operating efficiently and if there are tax-efficient investment strategies that could improve your tax situation.

support for environmental cause

5. Support for a social or environmental cause. With social impact investing (SII), you can support social or environmental causes while pursing investment returns by investing in such companies as those that produce clean energy technologies or are minority-owned firms.

What to discuss with your relationship manager: Share the social causes that are important to you and ask if SII might be an option.

Written by

Emily Howard

May 21, 2018

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Additional Resources

Increasing volatility in today’s bull market makes diversification an important investment consideration.

Uncertainty about the future is unavoidable — which is why flexibility should be part of your wealth planning strategy.

Emily Howard is a business and financial writer based in North Carolina. Images created from iStock

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Global Investment Strategy is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly-owned subsidiary of Wells Fargo Bank, N.A.

This article has been prepared for informational purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Individuals need to make their own decisions based on their specific investment objectives, financial circumstances and tolerance for risk. Please contact your financial, tax and legal advisors regarding your specific situation and for information on planning for retirement.

All investing involves risk including the possible loss of principal. Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Foreign investing presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.

Diversification does not guarantee profit or protect against loss in declining markets. Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns.

Dividends are not guaranteed and are subject to change or elimination.

Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors.

Alternative investments products employ alternative strategies and are more complex investment vehicles. They tend to be more volatile than other types of investments and present an increased risk of investment loss.

Real estate-based investing: There are special risks associated with an investment in real estate, including credit risk, interest rate fluctuations, and the impact of varied economic conditions.

Fixed income investments involve certain risks such as market risk if sold prior to maturity and credit risk especially if investing in high-yield bonds, which have lower ratings and are subject to greater volatility. All fixed income investments may be worth less than original cost upon redemption or maturity. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the value of your investment.

Income from municipal securities is generally free from federal taxes and state taxes for residents of the issuing state. While the interest income is tax-free, capital gains, if any, will be subject to taxes. Income for some investors may be subject to the federal Alternative Minimum Tax (AMT).

There can be no assurance that a manager’s overall investment or hedging strategy will be successful.

Mutual funds are subject to risks similar to those of stocks. Investment returns may fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed or sold, may be worth more or less than their original cost.

Socially Responsible Investing Strategies: A portfolio’s social policy could cause it to forgo opportunities to gain exposure to certain industries, companies, sectors or regions of the economy which could cause it to underperform similar portfolios that do not have a social policy. A socially responsible investing style may shift in and out of favor.