This might be the most frequently heard investment advice: ‘Diversify your portfolio’. Let’s take a closer look at why this is so highly recommended and the different ways to do it.
The primary reasons for diversifying are to limit your downside risk in times of market volatility and to protect yourself in the case that the few stocks or assets you hold turn out to be bad picks. A diversified portfolio is less of a gamble and a surer path to long-term wealth.
Another advantage of diversification, especially for the less seasoned investor, is to gain an understanding of the assets that make up one’s portfolio. An investor always pays more attention to the assets he/she holds, so diversification also offers the benefit of closing the knowledge gap with seasoned investors.
Ways to Diversify Your Investing Portfolio
There are many different ways to diversify your investment portfolio. Depending on their past or expected performance, knowledge of the assets/markets and their availability, an investor can choose to adopt one or a combination of the following. Personal values or political stances can sometimes become a factor as well. In such situations, an investor might choose to stay away from certain markets or commodities.
Let’s take a closer look at different ways to diversify your portfolio.
Diversifying Asset Classes
Investing in multiple asset classes is a popular way to diversify your portfolio. Fixed-income assets such as bonds, stocks and ETF, commodities, FX, and cryptocurrencies are some of the asset classes you can invest in. Moreover, the manner in which you trade in each asset class can change, such as simply buying/selling assets, options trading, or CFD trading.
How does owning different types of assets lower your risk? In the case that the stock market suddenly crashes, the other assets will likely keep your wealth intact. On the flip side, if the bond market or cryptocurrency market crashes, then your equities can balance your overall status. Adding additional asset classes to your investment portfolio is one of the easiest and most secure ways to diversify your wealth.
Diversifying Markets and Regions
You can diversify your holdings in stocks or ETFs by region or country. Many of us will find ourselves to be overexposed to the US stock market. DOW and NASDAQ enlist some of the largest and most successful companies in the world. But there is certainly a point where being overexposed to one particular market can be detrimental, or to say the least, limit your earnings. Likewise, investing in emerging markets’ exchanges can be lucrative, but risky. Similar to mixing low-risk assets with volatile assets, an investor can diversify the markets he/she deals in.
Another approach is to make regional picks. Trading region-specific ETFs can be an easy way to do this. The region can be geographically defined, such as ‘APAC (Asia-Pacific) markets’, or entail a similarity in their economies, such as ‘emerging markets’. Take a look at a globally diversified ETF or an emerging market ETF to hedge your portfolio and gain exposure to other regions.
Diversifying by Sector
It’s also not unusual to have a portfolio that is overweight in one particular sector. Investors can be inclined to rely heavily on industries they know well or work in, or due to their high yields in the past. For example, a lot of investors have invested in high-growth tech stocks recently.
While this approach may pay off, industry-wide volatility is always a risk. For example, the global shortage of microchips during Covid has affected the auto industry and computer manufacturers. Adding in stocks or ETFs from value sectors like finance, energy, or consumer discretionary could help to add a much needed stable foundation to your portfolio.
Often being overloaded in a specific sector like cybersecurity or electric vehicles can be detrimental as well. It’s not likely that all of the companies you hold will emerge as industry leaders. So hedge against those losses by choosing one or two leaders from a few different sectors instead!
Benefits of Diversifying Your Investments
The main benefit of diversifying your investment is to protect yourself against any potential risks. These risks can be excessive concentration in one or two assets, regions, or even sectors. Diversifying your investments helps bring balance to your portfolio and to your mind, so you don’t have to worry if the one stock you are overweight suddenly tanks.
Diversifying Your Portfolio
We’ve all heard stories about star investments of high-profile business persons, or trader stories that 10x their capital on a single asset. While these make great headlines and go viral on social media, remember that we never hear about the losses on such single-minded portfolios.
The reality for an average investor is different. For the vast majority of investors, a diversified portfolio is the safest way to ensure long-term capital growth without being drastically affected by short-term volatility.
Are you ready to build your diversified portfolio? Download Gratis today and get started to compound your wealth.