Diversifying your portfolio typically conjures images of stocks and bonds. Diversification helps mitigate overall risk by not placing all your eggs in one basket – in this way, as some assets decline in value, others tend to rise, thus helping protect you against losses.
Diversifying is easiest when investing in low-cost index funds that track various markets and sectors, though diversifying can become an ongoing task as you monitor your asset allocation percentages and rebalance them over time.
1. Diversify by Sector
Diversifying your portfolio by investing in stocks from different industries can help safeguard against losses from one sector or industry experiencing declines, by diversifying. If one area experiences stagnant or negative growth, other sectors or industries might see expansion and offset any losses that arise.
Style diversification is another effective strategy to broaden the breadth and diversify your portfolio within any sector, such as day trading or value investing that may alter short-term prices.
Mutual funds or exchange traded funds (ETFs) provide another simple solution for diversifying your portfolio. Both offer an assortment of bonds and stocks to reduce risk in your portfolio; selecting shorter-term bonds may further diversify it; as these tend to be less susceptible to changes in interest rate fluctuations.
2. Diversify by Region
Diversifying an investment portfolio involves diversifying by company size (small-cap, mid-cap and large-cap), sector and region. Diversifying in this way can reduce risk for small investors during market instability.
Diversifying by region can protect investments from the effects of particular country conditions. While one country might experience economic or political decline, another region could be seeing rapid expansion.
Investors should regularly evaluate their asset allocation based on their personal financial goals, risk tolerance and time horizon. Furthermore, it may be worthwhile working with a financial professional to ensure that their portfolio is appropriately diversified to help protect themselves from taking money out during market declines that reduces losses while missing potential gains later on.
3. Diversify by Asset Class
Diversifying across asset classes is one way to reduce your risk of major losses that could keep you from reaching your long-term goals. Diversifying involves investing in various investment vehicles with different responses to market conditions that work independently from each other.
Diversifying investments between equities and bonds can provide protection from both gains in one type and losses in the other, by spreading gains across both types of investments. With regards to equity investments, diversifying may involve selecting small-cap, mid-cap and large-cap stocks as well as growth and value strategies within them. In bonds, diversifying issuers (corporate and government) and maturities in order to limit exposure to credit risk and interest-rate risk.
Keep in mind that even the most diversified portfolio can change over time as certain investments appreciate or decrease in value, so periodic rebalancing is essential. Your advisor can assist in selecting an asset mix to meet both your goals and risk tolerance.
4. Diversify by Time Frame
Diversification cannot guarantee profits, but it can reduce investment risk exposures. For example, diversifying within an industry like transportation can help limit your risk by lessening its effect on your portfolio as a whole.
An effective portfolio requires diversifying assets across asset classes, such as stocks and bonds. A traditional 60/40 portfolio provides a good starting point, though you can expand upon it by investing in various market capitalizations (large, mid, and small cap stocks), industries, geographic regions, issuer types, maturity lengths etc.
Diversify by time frame by including both short- and long-term investments to balance out volatility and maximize potential returns. Many digital platforms can assist in building and managing diversified portfolios that suit your financial goals and risk tolerance.
5. Diversify by Income
Diversifying a portfolio effectively involves diversifying investments across a variety of asset classes. Different investments respond differently to market fluctuations and economic cycles.
Diversifying within individual asset classes is also critical. To protect against potential downfalls in any one sector, invest across industries like healthcare, technology and consumer goods so as to lessen any negatives in any one industry sector or investment vehicle. Furthermore, diversifying your bond portfolio across issuers (government versus corporate) and maturities (short term, medium term and long term bonds) helps mitigate against overconcentration risks.
Rebalancing is essential to ensure that a diversified portfolio remains on track with your original goals and risk profile. Rebalancing can be especially challenging during strong market rallies when the temptation arises to purchase more of the highest-performing assets.
