Mastering Diversification: A Guide to Smarter Investing

When it comes to wise investing, it's not just about selecting a few stocks and hoping for the best. The age-old wisdom of not putting all your eggs in one basket holds true, but the art of diversification goes beyond mere asset allocation.

Diversification, in the words of Jordan Taylor, a financial advisor at Core Planning, is a strategy that involves blending different asset classes, investment vehicles, and investment types. The ultimate goal is to maximize long-term returns while concurrently minimizing the risk of loss and market volatility.

Diversification entails mixing and matching various types of investment assets, ranging from stocks and bonds to commodities and even cash. The purpose of this strategy is to discover the ideal balance between risk and return, aligning with your investment horizon, goals, and risk tolerance.

Our belief at RiverFront Investment Group is that portfolios should be constructed with a deep understanding of the client's needs and risk tolerance. According to Adam Grossman, Global Equity Chief Investment Officer at RiverFront Investment Group, investors with a higher tolerance for risk can allocate more assets toward potentially higher growth or income strategies as their specific needs dictate.

Achieving effective diversification is a fine balancing act, often more art than science. While formulas like modern portfolio theory offer guidance on optimal diversification, simple rules of thumb are often sufficient for many investors. "We believe in simplicity, especially for personal investors. The most critical decision is asset allocation," says Grossman. For this reason, focusing on U.S. equity, international equity, and fixed income assets is often more crucial, with alternatives presenting opportunities from time to time.

One straightforward strategy is the "60/40 portfolio," which suggests allocating 60% of your investments to diversified stocks for growth and 40% to aggregate bonds for stability. This allocation aims to strike a balance between growth potential and risk mitigation.

"Different asset classes offer distinct return profiles during different macroeconomic and market environments," explains Michelle Cluver, Vice President and Portfolio Strategist at Global X ETFs. For example, equities and fixed income typically have a low correlation, meaning that fixed income can provide a buffer during economic downturns when equities face headwinds.

For investors looking to harness the full potential of diversification without delving into the complexities of individual asset selection, exchange-traded funds (ETFs) present a compelling option.

ETFs have the ability to encompass a wide range of assets within their underlying "basket," and their shares are traded on exchanges just like stocks. This provides real-time trading, high liquidity, and transparency. "ETFs can provide great building blocks that offer both diversification and the flexibility to tilt based on prevailing market views," adds Cluver.

Here are 10 ETFs to help investors build a diversified portfolio:

1. iShares Core S&P Total U.S. Stock Market ETF (ITOT)

   • Expense Ratio: 0.03%

2. iShares Core MSCI EAFE ETF (IEFA)

   • Expense Ratio: 0.07%

3. iShares Core MSCI Emerging Markets ETF (IEMG)

   • Expense Ratio: 0.09%

4. Vanguard Total World Stock ETF (VT)

   • Expense Ratio: 0.07%

5. Schwab U.S. Aggregate Bond ETF (SCHZ)

   • Expense Ratio: 0.03%

6. Vanguard Total World Bond ETF (BNDW)

   • Expense Ratio: 0.05%

7. SPDR Bloomberg 1-3 Month T-Bill ETF (BIL)

   • Expense Ratio: 0.1354%

8. Energy Select Sector SPDR Fund (XLE)

   • Expense Ratio: 0.10%

9. JPMorgan Equity Premium Income ETF (JEPI)

   • Expense Ratio: 0.35%

10. abrdn Physical Precious Metals Basket Shares ETF (GLTR)

    • Expense Ratio: 0.60%

The diversification journey can begin with a significant allocation to U.S. equities, given the dominance of the U.S. market. iShares Core S&P Total U.S. Stock Market ETF (ITOT) provides an affordable way to access U.S. stocks with an expense ratio of just 0.03%. It tracks the S&P Total Market Index and includes over 3,200 large-, mid-, and small-cap U.S. equities across all sectors.

For international diversification, iShares Core MSCI EAFE ETF (IEFA) is an uncomplicated choice. By tracking the MSCI EAFE IMI Index, IEFA encompasses more than 2,900 stocks from developed markets outside North America. It allows investors to diversify their portfolios internationally without the need for currency exchange, with an expense ratio of 0.07%.

Emerging markets offer growth potential, and iShares Core MSCI Emerging Markets ETF (IEMG) provides exposure to countries with rapidly growing economies. Tracking the MSCI Emerging Markets Investable Market Index, IEMG includes over 2,700 holdings from countries like China, India, Taiwan, Korea, Brazil, South Africa, and more. This ETF charges an expense ratio of 0.09%.

Investors can customize their equity allocation by blending ITOT, IEFA, and IEMG in different proportions, although this approach necessitates periodic rebalancing and trading. For a more hands-off approach, Vanguard Total World Stock ETF (VT) offers a solution. VT tracks the FTSE Global All Cap Index and holds more than 9,500 U.S., developed, and emerging market stocks. With allocations based on market-cap weight, it provides broad exposure to North America, other developed markets, and emerging markets. VT's expense ratio is 0.07%.

Inclusion of high-quality bonds in a diversified portfolio is essential for most investors to mitigate risk. Schwab U.S. Aggregate Bond ETF (SCHZ) is a cost-effective choice for U.S. bond exposure. Tracking the Bloomberg US Aggregate Bond Index, it offers access to more than 9,700 government Treasurys, mortgage-backed securities, and investment-grade corporate bonds across various maturities. With an expense ratio of 0.03%, SCHZ is a highly accessible avenue for diversified bond exposure.

For investors seeking international bond diversification, Vanguard Total World Bond ETF (BNDW) delivers. Tracking the Bloomberg Global Aggregate Float Adjusted Composite Index, BNDW combines two other Vanguard ETFs to achieve global bond exposure. It's a way to benefit from higher yields and different interest rate environments abroad while hedging against domestic bond market volatility. BNDW's expense ratio is 0.05%.

In a rising rate environment, cash and cash equivalents are making a comeback as viable assets with competitive yields. Investors can put their cash allocation to work using a Treasury bill ETF like SPDR Bloomberg 1-3 Month T-Bill ETF (BIL). It tracks the Bloomberg 1-3 Month U.S. Treasury Bill Index and is currently yielding 5.4%. BIL's expense ratio is 0.1354%.

Diversification isn't limited to asset classes; it also extends to sector-specific diversification. The Energy Select Sector SPDR Fund (XLE)

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