How do you protect your investments from market downturns and unexpected future events? The answer is diversification. If you’re looking to build your investment portfolio, diversifying is important.
Most of the people have heard the old saying “Don’t put all your eggs in one basket.” If a farmer were to stumble while bringing the basket of eggs back from the henhouse, they could end up in a messy situation. Those words of wisdom go well beyond farming; they also perfectly relate to the idea of not risking all your money on a single investment.
The logic is quite simple. If you invest in things that do not move in the same direction, at the same time or at the same pace, then you will reduce your chances of losing all of your money at the same time or at the same pace. A diversified portfolio can help protect your income and wealth during various stages of the economic cycle and provide good long-term returns.
FUN FACTS: The word diversification comes from the Latin words diversus, meaning “turned in different ways,” and faciō, meaning “to make” or “to do.
Here are some tips for diversifying your portfolio.
Spread your money across multiple asset classes
If you invest in a multiple asset class, your overall returns will be less volatile because losses or low returns from one asset class are offset against gains or high returns from another. You’ll also be less exposed to one economic event, so if a company or sector you’re investing in doesn’t perform well, you won’t lose all of your money. So, it’s important to diversify across different asset classes.
Diversify within an asset class
Even within asset classes it’s important to diversify, to provide further protection against unexpected events. For instance, when it comes to stocks, you should have different stocks in your portfolio for diversification. This can help manage your portfolio risk and minimise the impact of one stock having too much influence on the portfolio.
As for property, if you’ve already invested in residential property, you should consider investing in commercial property for further diversification.
Choose different industry sector
Different industry sectors perform better at different times, and some sectors are more volatile than others. This shows the importance of investing in multiple sectors within an asset class.
If you invest in stocks in various sectors, you’ll expose your portfolio to grow in different areas of the economy and it’ll be less vulnerable to a downturn in a specific industry.
Invest in a different companies in the same sector
If you have a stock in the same sector, consider having one leading company (larger capital) and one emerging company (smaller capital). For example, in the healthcare sector, you can invest in a hospital and in a pharmaceutical company. That’ll give you a good mix of companies across your portfolio. And if one company does poorly, you still get the benefit if another company does well.
Invest in both local and international markets
If you invest in the Australian market and in international markets, you’ll reduce your exposure to one market. Different markets peak at different times; for example, when the Aussie market is down, the US or Asian markets may be up.
You can invest in international markets directly or via an overseas share option in a managed fund, exchange-traded fund (ETF), or superannuation fund. Just keep in mind that when you invest some of your money overseas, changes in currency exchange rates can increase or decrease your returns.
KEY TAKEAWAYS
By diversifying your investment portfolio, you reduce the risk of being exposed to just one asset class, company, sector, or market. This in turn reduces the volatility of returns on your overall portfolio. And not only will having a diversified portfolio help you sleep better at night, but it’ll also set you on the road to wealth and success.
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