Diversifying your investment portfolio

Investments are one of the best ways to earn extra money, multiply capital, and achieve long-term financial goals. But for investing to be successful, it is important to choose the right assets and create a diversified investment portfolio. 

 

Our new article is devoted to the diversification of investment portfolio. We will tell you what diversification is, what kinds of diversification there are, and what its advantages and disadvantages are. 

Diversification: definition and main types

 

“No matter what your goal is, diversification is the key to successful investing”, — Corbin Blackwell, senior financial planner at Betterment. 

 

 

So what is diversification? It's a common investment strategy by which investors fill their portfolios with different types of securities and asset classes to grow capital and reduce the risk of loss due to market volatility. 

 

The main goal of diversification is to allocate assets and risks so as to make the best combination of assets of different returns and riskiness. For example, we know that stocks always generate higher returns than bonds. At the same time, their riskiness is also higher. Therefore, an investor may invest in stocks to generate high returns, and in bonds to stabilize profits. 

 

The main rule of diversification is to include in one's portfolio assets whose returns do not correlate with each other. That way, if a piece of news can affect your investments, it either affects part of the portfolio, or not at all, or has the opposite effect on another part of the investment. 

 

There are three types of investment portfolio diversification: by asset class, by industry and by country. Let us consider them in more detail. 

 

Diversification by asset class

Implies filling an investment portfolio not only with stocks but also with bonds, commodities, real estate. This issue requires a lot of attention since investing all of your funds in stocks of one company or even several, you take a risk. If one of these companies goes bankrupt or its financial situation deteriorates, your investment and returns will suffer. 

 

If you don't want the success of your portfolio to depend on just one asset type, spread your investments across different asset types to safeguard your capital. In addition, different asset types react differently to market events. This means that if one part of your portfolio suffers a loss, the other part may not be affected at all or may be affected positively. 

 

When investing in stocks, invest in assets of companies of different sizes, for example, buy securities of not only large corporations, but also small start-ups or mid-cap organizations. Also, it is worth investing in both international companies and regional companies. 

Diversification by sector

It means filling a portfolio with stocks and bonds from various sectors, for example, an investor may invest in assets of companies from industrial, financial, pharmaceutical, IT, etc. 

 

“A common misconception investors have been that if they buy a lot of stocks from different companies, their portfolio becomes diversified. Having many positions in your portfolio does not mean good diversification. Beneficial diversification is investing in assets in different market sectors that behave differently”, — Corbin Blackwell, senior financial planner at Betterment. 

 

For example, you've invested in the stocks of technology companies Apple, Amazon, Samsung. This means that your investment portfolio is 100 percent technology stocks, which is risky because if some negative event touches that sector, your entire investment portfolio will suffer. 

Diversification by country 

By allocating assets in your portfolio by country, you reduce the risk of losses due to events that occur in a particular country and affect the stocks of companies in that particular country the most. However, when choosing this type of diversification, it is important to remember that each country has its own laws, language, and taxation fees. All this information should be studied by an investor before making an investment. 

Advantages and risks of diversification in investments

The main advantages of investment portfolio diversification are minimizing the risk of losses, since with a proper asset allocation, your funds are invested in different assets and areas. In addition, by diversifying your portfolio, the investor receives new opportunities and the prospect of long-term growth. 

 

But, there are also disadvantages.

 

First, competent diversification takes a lot of time and effort, because the investor needs not just to study the market, but also to analyze it, choosing the best assets from different market sectors. 

 

Secondly, even the most diversified portfolio cannot save an investor from the market risk by 100% as there are factors which affect the whole market. For example, the world crisis, pandemics, etc. 

 

Is diversification important?

To summarize, we can say that diversification is very critical for conscious and safe investing. Correct allocation of assets in an investment portfolio will have a positive effect on the rate of return and protect the investor in the event of a decline in a particular market segment. 

 

But, the main thing to remember is that even diversification cannot guarantee 100% success and carefully study the information when choosing assets for investment.