The Best Way to Invest Money: A Diversified Portfolio

If you were to ask 10 different people to tell you the best way to invest money, you’d probably get 10 different answers. “Only invest in growth stocks!” “Fixed income is the way to go!” “Crypto to the moon!”

But the truth is that there is no single “best” way to invest money that will apply to every individual in every situation. The ideal investment strategy for you will be one based on your goals, timeline and your risk tolerance.

But if there’s one trait that many of the best investment strategies share, it’s diversification.

Below, we define diversification, explain why it matters and highlight the different ways that you can diversify your investment portfolio as you start investing.

The best way to invest money

While investment professionals can make educated predictions about parts of the economy that may perform better than others, the reality is that no one truly knows what tomorrow holds. Even predictions that seem as though they will “obviously” come to pass can be wrong, thanks to events we can’t forecast, from unexpected political developments to black swan market events. Strategically diversifying your investment portfolio to match your personal risk tolerance and investment timeline can help make sure events like this don’t tank your entire strategy.

What is diversification in investing?

In the context of investing, diversification is the practice of spreading your investments around instead of concentrating your money in just one asset class. It helps to make sure you don’t put all your eggs in one basket.

Why is diversification important?

If you invest all of your money into a single asset—for example, a single company’s stock—whether or not you reach your investment goals will depend entirely upon the performance of that one asset.

Sure, it’s possible that the stock could perform well and you’ll realize gains, but there’s no guarantee. It’s just as possible that your one investment will lose you money instead. In a worst-case scenario, if the company fails, you could lose everything.

That’s a lot of risk riding on one single investment.

When you diversify your investments across multiple assets, you’re essentially spreading this risk around. If you hold stock in 10 different companies, for example, and one of them fails, you’ve only lost 10 percent of your total investment (vs. the total loss you’d experience in the scenario above).

Diversification helps on the flipside, too. If an asset starts to perform very well, you’re able to take advantage of upsides. Typically not all of your assets will perform well at the same time. For example, bonds usually increase in price when stocks decrease (and vice versa). Owning both helps you mitigate your risk so that not everything is going down at once (and you can take advantage of growth when its happening).

And therein lies the beauty of diversification: It helps to smooth the ups and downs while mitigating certain types of investment risk. It can also reduce volatility over the long term, especially when compared against holding just one investment or investment type, and makes it more likely that you’ll experience growth over time.

What does diversification look like?

Diversification can take a number of different forms.

For example, you might diversify across asset classes. This means you are allocating a different percentage of your portfolio to stocks, bonds, cash equivalents, real estate, commodities, etc.

Why would you diversify across asset classes? Because each asset class responds differently to economic factors like inflation, market sentiment, interest rates and more.

Imagine a market environment in which stocks are performing badly but bonds are performing well. Having a portion of your portfolio allocated to each means that even though one portion of your portfolio might be seeing losses, another portion might be seeing gains.

Likewise, you might diversify within asset classes. For stocks, that might mean strategically buying large, medium and small sized companies as well as companies located in different parts of the world. With bonds, you might buy different types of bonds and bonds that last for different lengths of time.

The goal is to spread out your risk of loss while positioning yourself to take advantage of the upside when one particular segment of the economy performs well.

How to diversify your portfolio

While it’s possible for anyone to build a portfolio by buying individual stocks, bonds and other assets, such an approach is uncommon. Most people simply don’t have the time or knowledge, experience or desire to manage their investments so closely.

Luckily, there are many ways to diversify your investments without having to buy individual securities yourself. Investing through funds is one great strategy that many investors embrace.

When you purchase shares of an investment fund, you are essentially buying a share of all the different assets that fund holds. This provides instant diversification without needing to sift through investments one by one. Mutual funds (like target-date funds) and exchange-traded funds (ETFs) are great options for this.

And if you want to be completely hands-off? Work with a financial advisor or wealth manager. These individuals are trained to construct and manage investment portfolios that helps match the needs of their clients in the context of their unique financial plan, circumstances and goals.

Diversification beyond your investments

Investing is a powerful tool that you can use to grow your wealth over time, but it’s just one piece of a larger financial plan. While it’s important to think critically about your investment strategy, it’s also important to make sure you have a view of how your investments fit within other parts of your financial life.

For example, having a well-stocked emergency fund can help you prepare for life’s unknowns and reduce the likelihood that you will need to tap into your investments to cover emergencies, giving your money more time to grow.

Life insurance, on the other hand, offers you the peace of mind that comes with knowing your family will be taken care of in the event that you were to pass away. And certain forms of life insurance also build cash value, which is guaranteed to grow over time and is available for you to access while you are still alive.

In a very real sense, ensuring that the other parts of your financial plan are appropriately funded and maintained can be thought of as a form of diversification that allows you to further manage your financial risk.

How to invest money with a financial advisor

When it comes to diversification in investing and financial planning, you should avoid a one-size-fits-all approach. You are unique. Your financial goals and situation are unique. Your strategy should also be unique.

While most financial plans use similar ingredients, the amounts—along with how and when each ingredient is used—are based on your goals, objectives and tolerance for risk. Working with a financial advisor can help you focus your goals and objectives and make financial decisions that support your long-term goals.

A Northwestern Mutual financial advisor will get to know you and your goals and make recommendations to help you reach those goals, showing you how your investing strategy works with other parts of your financial picture. Some advisors may even be able to help take some of the work of maintaining your portfolio off of your plate so you’re able to put your focus on staying on track to reach your goals in the future.

All investments carry some level of risk including the potential loss of all money invested.

No investment strategy, including diversification, can guarantee a profit or protect against loss.

Utilizing the cash value through policy loans, surrenders, or cash withdrawals will reduce the death benefit; and may necessitate greater outlay than anticipated and/or result in an unexpected taxable event.

Not all Northwestern Mutual representatives are advisors. Only those representatives with the titles "Financial Advisor" or "Wealth Management Advisor" are credentialed as NMWMC representatives to provide advisory services.