Most people are aware of the importance of diversifying their portfolios. What they arent clear on is how to do that, and then how to proceed once thats done. Its not enough just to choose the right balance of investments. You also need to rebalance them once a year to ensure that your investments are on track with your goals.

How to Diversify the Portfolio

The first step to investing is choosing a diverse portfolio of investments. You can take several strategies to find the right asset allocation:

• Follow an age-based chart
• Follow a risk-based chart
• Invest broadly by asset class
• Invest broadly by sector (this link is an example of what one person did, not a recommendation)

If you choose a risk-based chart, you should decrease the risk as you age. The closer you are to retirement, the safer your money should be.

Youll find a wide range of options within each of these categories, so research carefully to compare expenses, performance, and the type of investments they hold. Then allocate your money accordingly. If you have a 401K, you may be able to allocate your money automatically every month, but youll have to choose a method for carving up investments in taxable and personal non-taxable accounts.

How to Rebalance the Portfolio

As the market moves, different sectors or asset classes will zoom while others lag behind. Mark a date on your calendar each year to rebalance your portfolio to your intended allocations. That reduces the risk of steep slides and climbs. Using a calendar date to rebalance also prevents you from trying to goose your returns by delaying the rebalancing. I did that once, and watched the stock collapse the day before I planned to sell it. If Id gotten out when I should have, I would have made $18,000. Instead I made $6,000.

If youre rebalancing 401Ks and IRAs, then compare the performance of your current holdings with your targets. If one has zoomed up, sell a little and use the proceeds to buy more of something thats below your targeted allocation. This is also an opportunity to adjust the risk level or asset allocation classes if your needs have changed.

If youre rebalancing a taxable investment, it gets a little more complicated. When you sell high-flyers, reduce the tax impact by selling a loser. Be hard-nosed about this dont let your emotions prevent you from selling a stock thats going in the tank. The odds of it recovering are not good. Trust me. I rode Lucent all the way down. You can use losses to write off all your capital gains, plus $3,000 (in other words, you can have a capital loss up to a maximum of $3,000.)

Dont Hold the Same Assets in Multiple Accounts

If youve saved the max in your retirement accounts and still have money to invest, dont just duplicate your protected holdings. Instead, branch out to cover more sectors or asset classes. According to Money. you should hold your taxable bonds in your retirement accounts and keep your stock funds in your taxable account so you can harvest the losses.

Once you choose a diversification plan, select your investments, and set a date to rebalance, you can let your money grow without worrying about it day and night. I use a combination of asset classes and risk for my asset allocation. Whats your approach?

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