Keys to a Diversified Investment Portfolio

investment portfolio
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Minimize risk with a management strategy that pulls together different types of investments.

Authors: Alison Banney & Ryan Brinks

 

Experts say a diversified portfolio is key to weathering any market. But you may be confused as to whether your money is truly diversified. We’ll show you easy ways to diversify your portfolio.

What is a diversified portfolio?

A diversified portfolio invests in different asset classes like stocks, bonds and real estate to minimize risk when one asset class falls in value.

An easy way to diversify your portfolio is to invest in exchange-traded funds (ETFs) and mutual funds. These professionally-managed funds invest in baskets of different stocks or bonds. You can also invest in real estate investment trusts (REITs), commodities, precious metals and more.

But to be truly diversified, think global. That means investing in stocks and funds that focus on different regions and market sectors. When diversifying your portfolio, seek asset classes that have low or negative correlations to one another. That way if one asset class goes down, another in your portfolio can go up.

Here are some key ways to diversify your portfolio.

Diversify by Options to choose from
Asset type Investments like cash, stocks, bonds, options, commodities and real estate.
Market sector Investments in any of several industries within 11 generally accepted sectors: communication services, consumer discretionary, consumer staples, energy, financials, health care, industrials, IT, materials, real estate and utilities.
Objective You can invest for growth, income, safety, value, hedging or speculation, among other reasons.
Asset size You can invest for growth, income, safety, value, hedging or speculation, among other reasons.
Asset location Investment in different markets across the world, including North America, Europe, Asia, developed countries, emerging markets, etc.
Time horizon Short-term, medium-term and long-term investment ideas.
Volatility Assets with more or less inherent volatility than others, measured by its beta — a measure of risk.
Liquidity How quickly you can find a buyer or seller. For instance, popular stocks can be bought or sold in seconds, while some real estate can take years.
Tax liability You can place your money in both taxable and tax-advantaged investment accounts.
Type of analysis You can diversify even how you pick your investments by combining fundamental and technical analysis.

5 signs your money is diversified

Taking into consideration that there are numerous ways to diversify and you can be too diversified, there’s no hard-and-fast rule for achieving a proper balance. So here are some signs that you’re probably in good shape.

1. You’ve got a sizable portion of your money in four or more different asset classes.

The most common portfolio allocations have at least 10% of your money invested in asset classes like cash or money market funds, stocks, bonds and property. Kudos if you also have money in commodities, like the popular gold, and alternative investments.

2. At any given time, at least one part of your portfolio is performing well.

Like a lunch buffet, a diversified portfolio offers something for everyone, no matter their appetite that day. Even if most investments are falling, a well-diversified portfolio will include a few rising investments.

3. You invest in exchange-traded funds.

Many ETFs provide instant diversification within a specific asset class or market sector. But you may need a few different ETFs to achieve a recommended diversification across all markets.

4. You aren’t fazed by daily volatility.

A well-diversified portfolio means you generally aren’t concerned about what the market does or what news is hyped on any particular day. If small market fluctuations are keeping you up at night, it could be a sign that you have too much money invested in one particular asset class.

5. You don’t listen to just one source for news, advice or ideas.

Risk and bias go hand in hand. Don’t settle for only conventional wisdom. Learn about other investment approaches, strategies and ideas, then find a balance that aligns with your financial goals and circumstances.

The benefits of a diversified portfolio

The main goal of diversifying your investments is to create a portfolio that achieves the highest returns at the lowest overall risk. A well-diversified portfolio can safeguard you against market volatility and cyclical market events while helping you to reach multiple financial goals at once. Here are five key ways to diversify your portfolio.

Manage your risk.

Safe life advice says to avoid putting all your eggs in one basket. That also applies to investing, where investing all your money in one investment class could mean losing it all if that investment’s performance tanks. With a diversified portfolio, you’d lose only the money on your investments in that asset, rather than across your whole portfolio.

Say you invested only in American stocks. Your entire investment portfolio would be affected if the US market crashed. But if only a quarter of your portfolio was in stocks, the remaining three-quarters of your portfolio could provide the buffer to help you weather the storm financially.

Broaden your opportunities.

If you choose to invest in a particular asset class, diversifying your portfolio within that class gives you more opportunities to own a winning asset while also helping minimize risk to your investment portfolio as a whole. For example, investing across the healthcare, utilities, consumer discretionary and tech sectors gives you better odds of earning a positive return over time than if you were invested in just one of those sectors, as different sectors outperform the market at different times.

Reduce market volatility.

When you spread your money across different investments, extreme moves in one asset have less of an effect on your total portfolio, making your overall returns more consistent and predictable. Using the same sectors as above, healthcare and utilities are essentials that often experience steady demand and therefore lower volatility, while discretionary spending and technology can fluctuate more with trends and economic conditions, thus higher volatility. Mixing them together will lift the potential for higher returns while lowering the spikes in volatility.

Take advantage of compounding.

Depending on how you set up your portfolio — and when you rebalance it — compounding within a diversified portfolio can produce better results than the simple average return.

Let’s say you invest $100,000 into Portfolio A. Portfolio A includes two stocks, each stock returning 5% a year. That means Portfolio A averages 5% a year overall. An average 5% return over 10 years could turn your $100,000 into $325,779 — or $225,779 over your initial investment.

Now let’s say you invest $100,000 into Portfolio B, which also includes two stocks. Stock 1 returns 0% a year, while Stock 2% returns 10% a year. Portfolio B also averages 5% a year overall, but due to compounding, after 10 years your $100,000 could turn into $359,374 — or $33,595 more than Portfolio A.

Can you be too diversified?

Yes. Spreading your investments too thin can lead to a dilution of your returns. Experts suggest that beyond a range of about a dozen to three dozen assets, additional diversification provides little, if any, additional benefit. You could also lean too heavily on lower-quality assets, which can dilute your higher-quality assets, providing you with lower overall returns.

 

Disclaimer: The value of any investment can go up or down depending on news, trends and market conditions. We are not investment advisers, so do your own due diligence to understand the risks before you invest.

 

Sheri Bechtel, Editor of Share Trading and Investing, Finder

What are some mistakes investors make most often when trying to diversify their portfolio?

“Some investors try to diversify their portfolios based on trends. Dogecoin might be a good example of this. If you believe crypto is a good way to diversify your portfolio, that’s fine, and you should do your research. It’s important not to jump on bandwagons.

Before choosing an asset class, make sure it’s suitable for your long-term financial goals. Also make sure you fully understand what you’re getting yourself into. If you have a relatively low risk tolerance, stick with tried-and-true –– and relatively safe –– investments. If you have a  higher risk tolerance, make sure you understand the risks associated with certain investments before you dive in.”

What are some tools to consider to help facilitate diversifying a portfolio?

 

I would make sure your portfolio includes a healthy balance of things like stocks, bonds, ETFs, and mutual funds, keeping in mind that the specific investments in your portfolio will depend upon your personal goals and your risk tolerance. And be sure to rebalance your portfolio regularly to make sure your goals are being met. Robo-advisors will do this for you automatically, so they’re a great way to diversify for hands-off investors.


Bottom line

Diversifying your investment portfolio is an effective way to minimize the risk of losing money. But it’s not the only way to manage risk. For instance, you can be invested in the right assets but get the timing wrong.

Consider other risk management strategies as well — particularly when you plan to buy and sell — and review your overall investment plan periodically to adjust your assets. For an overview of the many aspects involved in buying assets and associated risks, read our comprehensive guide to investing.

*This article first appeared on Finder.com*


Additional resources:

Everlasting Stocks Review

Productive Things to Do With Money

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