How to Diversify Your Portfolio
As an investor, one of the key concepts you will come across is portfolio diversification. It’s an investment strategy which involves holding different securities with different characteristics, meaning that your risk is spread across a range of investments which can include stocks, bonds, real estate, cash, and commodities. Diversification can help protect you from downturns in the market, making it a great long-term goal for any investor. In this article, we’ll explain why portfolio diversification is important and steps to take to diversify your portfolio.
Why Is Diversification Important?
Diversification is important for any investor, no matter their level of experience or size of the portfolio. The main advantage of diversification is that it can help lower the risk of large losses if the prices of one type of asset falls. If a large part of your portfolio is invested in just one type of asset it could be a big hit in times of market downturns.
It’s also important to make sure that your portfolio contains a good mix of different types of assets. This will help you to spread your risk, gain exposure to different markets, and create potential for different types of returns, meaning that one type of asset can offset losses in another.
Steps to Diversifying Your Portfolio
1. Set your financial goals.
Before diving into a diversified portfolio, it’s important to first think about why you’re investing and what you want to get out of it. Setting your financial goals is an important step in creating an appropriate portfolio for you. Think about whether you’re looking for short-term or long-term gains, or if you’re simply looking for a steady income. Consider factors such as your age, risk tolerance, and investment experience. Understanding your long-term vision will help you set a plan in motion and will become your point of reference as you continue to invest.
2. Create an asset allocation.
Once you’ve established your goals, it’s time to create an asset allocation. Asset allocation is a strategy that involves dividing your portfolio across different asset classes, such as stocks, bonds, cash, and commodities. When coming up with your asset allocation, it’s important to think about your risk tolerance and investing time frame. Many financial advisors suggest that your portfolio should be split evenly across stocks and bonds, with smaller percentages allocated to cash and commodities. You don't have to be a finance expert to come up with the appropriate asset allocation. Online calculators or apps can be used to help you come up with the perfect mix of assets.
3. Choose investments and securities.
Once you’ve established your asset allocation, it’s time to consider potential investments. When selecting investments, consider factors such as volatility, liquidity, fees and expenses If you’d like to keep things simple, exchange traded funds (ETFs) are a great option. ETFs are portfolios of different securities bundled together and traded in the stock market. They offer diversification in one single investment. Mutual funds are another great option, as they are made up of a collection of stocks and bonds.
4. Minimize trading and transaction costs.
As you embark on your diversification journey, it’s important to keep an eye on trading and transaction costs. Many investors choose to carry out their own research and buy and sell investments through an online broker, but these transactions come with trading and transaction costs. Consider using a financial advisor or a roboadvisor to help minimize these costs. Roboadvisors use factors such as your risk tolerance, time frame and financial goals to provide you with personalized advice.
Diversification is a key strategy for investors and can help to reduce risk and provide potential for higher returns. The most important step to diversifying your portfolio is to start off by setting your financial goals, no matter how small or large they might be. From there you can move onto creating an asset allocation and choosing your investments accordingly. Finally, make sure to consider trading and transaction costs, as each transaction you make comes with a cost.