Risk is an integral part of an investment that yields higher returns. Obviously, you do have the interest rolling from your bank accounts and fixed deposits that guarantee certain returns but they do not fetch you the highest return that your capital could potentially get you. Stocks and bonds can bring you higher returns but they come with their own set of risks. If the market was about to crash tomorrow, your stocks would have left you a negligible amount as returns. However, there is a way to tackle this risk associated with the investment. It is called – ‘diversification’. Diversification of your portfolio (the collection of financial assets and investment tools) acts as a seat belt in your long drive of the investment journey. Or even better, it is the giant bar across your lap on a high-rise roller coaster that keeps you from flying off the ride. You get the point, right? Now that you know why diversification plays a life-saving role in your investment journey, let’s understand how to diversify your portfolio.
You must have heard the idiom – Don’t put all your eggs in one basket, that is exactly what diversification preaches. It is the central thesis on which the concept of diversification lies. A diversified portfolio helps you to minimise the risks while investing for the long term. It allows for a decent amount of high-return investments by offsetting possible risks through increased stable alternatives. Since it reduces the risk in your portfolio, you are likely to experience lesser bumps in your investment journey.
The rationale behind the concept of diversification is simple—taking an average, investment portfolios composed of different kinds of investments yield higher returns and pose a lower risk compared to any individual investment within the portfolio.
Guide For How To Diversify Your Portfolio
By now you must have already understood why diversification is crucial. Now let’s see how you can achieve it through the following tips for diversifying your portfolio.
Widen Your Asset Allocation
Broadly speaking, the types of investments boil down to two basic types – stocks and bonds. While stocks are seen as high-risk with high returns investment, bonds are usually observed as safer and stable with lower returns. You should divide your money between these two options smartly to reduce your risk exposure. The trick lies in finding the equilibrium between risk and surety.
Asset distribution is typically based on age and lifestyle. At a younger age, you can take huge risks on your portfolio by opting for stocks that offer high returns. While at an older age, you should consider increasing the percentage of bonds in your portfolio.
If you are a student interested in investing then you must check out: Tips for Students Interested in Investing
Spread The Wealth
One thing to be kept in mind while investing is that you should not involve emotional attachment here. Investing in just one company because you use it often or because you trust it a lot, can prove to be detrimental. Similarly, investing in just one sector puts you at higher risk. While equities can be wonderful, there are other fantastic options to consider as well.
Mutual Funds, Exchange-Traded Funds (ETFs), Real Estate Investment Trusts (REITs) and bonds are a few other options that should be considered while diversifying your portfolio. Incorporating these options in your portfolio is amongst the best ways to diversify your portfolio.
ETFs are considered a great investment option. It acts as a basket of different stocks giving you instant diversification. If you are not aware of what an ETF is and how it functions then do consider reading this blog: What Is An ETF? A Beginner’s Guide
Adding a few fixed-income solutions enables you to further hedge your portfolio against market volatility and uncertainty. This is why index funds or bond funds are appreciable options in your portfolio. By choosing this option you are investing in securities that track various indexes. Index funds make for an amazing long-term diversification investment.
Also, you can invest in international markets to expand your portfolio and explore the international markets. Foreign stocks are an exemplary option as they tend to perform differently and nicely balance the domestic-heavy portfolio.
A well-diversified portfolio should include a combination of:
- Exchange-traded funds
- Mutual funds
Diversify Within Individual Types of Investments
You should also diversify within each of the categories mentioned above by investing in companies and bonds of varying types and sizes. So if you are taking a particular sector then do not just give in all of your money into one single company. Analyse the top-performing companies and see the returns they typically offer. Once that is done, you can then buy a relatively lesser number of shares of a company that is new and promising; while you could buy a large number of shares of a company that is well-established and long-running. This way, you can achieve maximum diversification and it is one of the best ways to diversify your portfolio.
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Identify Negative Correlations Asset Classes | Most Important Tip On How To Diversify Your Portfolio
As we already told you, investing in different sectors is a wise decision. Now if you keep one more thing in mind then the diversification of your portfolio will surely be unparalleled. That one golden tip is – Identify assets that have a low or negative correlation. Not sure what this means? Let us help you out. Spotting investment options that behave in the opposite manner is what we are talking about here.
If you diversify your portfolios in sectors that go up and down at the same time due to their dependency on each other then you are bound to incur losses when they fail. An example of this would be investing in the petroleum industry and electric vehicle sector at the same time. So, if the prices of fuel lead to a depreciation in the value of the petroleum industry; you will still make a profit owing to the electric vehicle sector which will be a part of the booming market.
Recommended Reading: How To Manage Finances Effectively As A Student
Last Words | How To Diversify Your Portfolio
The purpose of investing is to give your money the opportunity to grow and help you work towards your other life goals. The earlier you start, the better it is since you give your investments more time to reach their potential. Keep in mind the above-listed ways on how to diversify your portfolio and you will be ready to fly high.
Thank you for reading this blog ‘How To Diversify Your Portfolio – The Correct Ways’. If you enjoyed reading this blog and would like to continue reading more about investment then do check out our following blogs.