Diversifying your portfolio is integral to reaching your investment goals and protecting against market fluctuations by spreading risks across asset classes, industries and regions.
Investors commonly diversify by holding both stocks and bonds in their portfolio, but you can also diversify using other factors, such as company size, industry, geography or term lengths.
Asset Class Diversification
One of the easiest diversification strategies involves spreading investments among multiple asset classes. A portfolio can become diverse by investing in stocks, bonds, and cash – each offering its own set of risks and return potentials.
Diversifying within each asset class is also key. For instance, diversifying between large cap stocks and small cap stocks can help lower overall market exposure while diversifying between domestic and international markets can help mitigate country-specific risk while taking advantage of global growth opportunities.
One way to diversify is to invest in investments with low correlations between asset classes. For example, bonds typically exhibit lower returns but greater stability. Investors can further diversify by adding real estate or companies that are in different stages of development to their portfolios.
Financial advisors can assist in selecting an optimal level of diversification for your investment portfolio and offer strategies such as dollar cost averaging, sector allocation and surety selection.
Geographical Diversification
Diversification can help investors meet their financial goals through investments. Depending on your time horizon and risk tolerance, various asset class, sector and geographic diversification strategies could work well.
International investing can offer many advantages. It allows investors to capitalize on emerging economies’ rapid expansion while mitigating any economic events impacting more established markets.
Accessing multiple economies can also provide businesses with greater market flexibility with an edge in terms of growth. Take for instance a wearable technology business selling devices across several regions: If a travel event impacts negatively on sales in one region, that company might experience sales losses; by expanding operations into another country they could mitigate any detrimental economic repercussions from such an incident. Investing in regional real estate offers another great way to take advantage of global economies while diversifying away from stock market volatility.
Sector Diversification
Portfolio diversification involves investing across various sectors within an asset class. This minimizes the potential impact of losses in one sector on overall returns for your portfolio; for example, when oil prices decline, companies in the energy industry experience declines in share prices; however investors in other industries could experience gains that offset those experienced by those involved in oil.
One strategy to diversify is purchasing the shares of companies at different stages in their lifecycles. Newer, faster-growing firms tend to present higher risk/reward profiles than older, more established entities.
Investors should also carefully consider how the vehicles used to hold risky investments could alter the effectiveness of diversification strategies. If a large percentage of an investment portfolio is held in one stock that rapidly depreciates in value, selling may become necessary at a loss.
Investment Vehicle Diversification
Diversification should be a cornerstone of your investment strategy, as it can limit the damage done by poor performing investments on overall returns.
Diversifying a stock portfolio by investing in companies at various stages of growth is one way to do just this, because newer firms often boast higher growth rates – and come with increased risks compared to established firms.
Consider also that various investments often respond differently to economic events and market fluctuations. For instance, stocks may suffer in a decline while investments like real estate or commodities might withstand it better, providing relief in your overall returns.
Mutual and exchange-traded funds offer investors a diversified exposure to various asset classes, sectors and geographic regions. An independent financial adviser can assist in helping you understand your options and develop an investment diversification plan tailored specifically to your personal goals and risk tolerance.
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