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NerdWallet: Stocks, bonds and more: A primer on diversification for new investors

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This article is reprinted by permission from NerdWallet.

A majority of U.S. adults (59%) are curious about alternative investments, according to a new NerdWallet survey. Alternative investments, or “alts,” are just about any asset that isn’t a stock, a bond or cash, like real estate, cryptocurrencies or commodities such as gold or oil. The most popular reason Americans cite for their alt interest? Diversification.

More than 2 in 5 Americans interested in alternative investments in the future (44%) say it’s because they want to diversify the type of investments they have, while a quarter (25%) say it’s because the stock market is too volatile. In truth, history shows that despite periods of volatility, the stock market tends to go up over time. And there are many ways to diversify your portfolio — from solely within the stock market to a mix of assets that includes alts — depending on your interests, tolerance for risk and the time you have to dedicate to investing.

Should I even invest right now?

According to the survey, about a third of Americans (33%) don’t think now is a good time for them to invest in the stock market. While investing is a great strategy for building wealth over a long period, it’s best to make sure immediate needs are met first, particularly during financially precarious times.

Start by assessing your financial stability. Ideally, you want to have a steady job that allows you to pay for necessities, no high-interest debt and an emergency fund. One rule of thumb for such a fund is to set aside three to six months of expenses, but even $1,000 can help you weather a few unexpected hits to your finances. And if you have a retirement plan at work, such as a 401(k), and your employer offers matching dollars, contribute at least enough to earn the full match, because that’s free money.

Watch: What if I keep my money in a savings account instead of investing it?

Once those foundations are in place, investing more broadly is a great next step to securing your financial future. And diversification is key.

Why is diversification important?

The saying “Don’t put all your eggs in one basket” certainly applies to investing: Don’t put all your money in one stock. Because if that stock tanks, it could put your future goals at risk.

Instead, diversifying your investments across a range of assets can decrease the chances that one poor performer will significantly harm your progress. It may sound daunting, but you don’t have to be an expert stock picker to diversify your portfolio.

Diversifying your investment portfolio in 3 steps

Choose funds that include many different stocks

An easy, affordable way to diversify within the stock market is through index funds. An index fund is a type of mutual fund whose holdings match or track some market index. For example, a fund that tracks the S&P 500 SPX, +0.52%  , which comprises 500 of the largest companies in the U.S., might buy shares from each company on the index. An investor then buys into the fund, whose value will mirror the gains and losses of the full index it tracks, and it costs far less than if you tried to buy 500 individual stocks.

Also see: The Fed has a new approach to inflation: What it means for your savings, credit-card debt — and your mortgage rate

When choosing an index fund, pay attention to the costs — primarily the expense ratio, essentially an annual fee that’s expressed as a percentage of your investment — and the minimum amount of money required. If you don’t have the time or desire to dig into specific index funds, a robo adviser can also be a good choice. Robo advisers use computer algorithms to manage investment portfolios and will choose investments for you that take into account your goals, timeline and risk tolerance. They charge their own management fees but are cheaper than hiring a human investment adviser.

Consider adding bonds

For some, an all-stock portfolio, even when diversified using index funds, may be too risky for comfort. Enter bonds, which can diversify your portfolio even more.

Bonds are a fixed-income security that promises regular interest payments over time. As you get closer to retirement and start to need the money you’ve saved, you might allocate more money to bonds to protect your portfolio from market swings. One rule of thumb is that the percentage of stocks you carry is 100 minus your age, with the rest going to bonds. So if you’re 25, you’d invest 75% in stocks and 25% in bonds.

Also see: The U.S. dropped majorly on the index that measures well-being — here’s where it ranks now

But everyone’s situation is different, and you should take your goals and your tolerance for risk into account when deciding how to invest. Again, a robo adviser can handle this for you if you opt to go that route.

Keep alts as a small part of your portfolio

Adding alternative investments to your portfolio can also diversify it, but consider the downsides of investing heavily in them. Alternative investments may net higher returns than the stock market, but they also may come with higher fees, less liquidity and more overall risk. Many financial advisers say to keep these investments to less than 10% of your portfolio.

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Erin El Issa is a writer at NerdWallet. Email: erin@nerdwallet.com. Twitter: @Erin_El_Issa.