You will often hear that diversifying your investments is a crucial strategy to mitigate risk(s).
What you will find less often is exactly how to do this.
Read on to find out how you can diversify your portfolio, considerations you need to make, and what to look for as you continue, or begin, your investment journey.
First of all, it is important to know just what diversification involves.
In brief, it involves spreading your investments across various asset classes, sectors, and geographies, with the goal being to reduce exposure to any single investment, thereby minimising the impact of poor performance in one area on your overall portfolio.
Using equities as an example, you would invest in more than just one single company.
The reason you may want to consider diversification is quite simple.
It aims to reduce risk, enhance returns, and achieve a good balance for stability in all market conditions.
There are many asset classes, even beyond what you will see below.
However, the first step in diversification is understanding the main different asset classes.
These include:
Equities represent ownership in a company, and bonds are loans to governments or corporations.
Cash includes savings accounts and money market funds.
Real estate investments are in property, and commodities invest in other physical assets like gold or oil.
There are many methods of diversification, including between sectors, geographies and within asset classes themselves.
Investing in various sectors would mean spreading risk between sectors such as technology, healthcare, energy. and consumer goods.
Each sector offers different advantages (and disadvantages) such as high growth but volatile, steady but less growth, etc.
Geographical diversification does what it says on the tin; spreads risk between different countries and regions.
This can help with risk associated with economic and political instability.
Domestic investments include those within your country of residence.
International investments include exposure to global markets.
Diversifying within asset classes helps you differentiate between large-cap stocks, small-cap stocks, growth stocks, or value stocks.
Large-cap are generally established companies, small-cap are, you guessed it, smaller companies (but with high growth potential and more risk), growth stocks are those that are expected to grow faster than the market, and value stocks are companies trading below their intrinsic value.
Investment funds like mutual funds and exchange-traded funds (ETFs) are excellent tools for diversification.
They pool money from many investors to buy a broad range of assets, providing instant diversification often at a very low cost.
This question is an entirely new article in itself!
There are many debates over how much is too much, but one thing is for certain: it depends on your personal circumstances.
The key is finding the right balance with enough diversification to manage risk without limiting your growth potential.
Please note that all content within this article has been prepared for information purposes only. This article does not constitute financial, legal or tax advice.