Diversification refers to a financial strategy that entails blending different types of investments into a single portfolio. This strategy lowers an investor’s exposure to any one kind of asset class by allocating investments to a variety of financial instruments and sectors.
By diversifying one’s investment basket, an investor can protect themselves from various risks associated with investing including “specific risk”. Specific risk typically affects a small number of assets and can be mitigated through diversification, which lowers the portfolio’s risk by lowering the total standard deviation of investment returns. Thus, the volatility of an investment portfolio is reduced through diversification. As a result, diversification has the potential to improve portfolio performance.
Remember, investing always carries risk. As investors, we must ensure our portfolio has a level of risk that we can tolerate!
A well-diversified portfolio includes a mix of different assets.
Here are some tips to diversify your portfolio:
Every investor has a different investment horizon and is comfortable with different levels of risk. Thus, asset breakdowns are different between different investment portfolios. For example, one portfolio could be 50% bonds, 20% stocks, and 30% short-term investments while another could be 80% stocks, 15% bonds, and 5% short-term investments.
Traditionally, the different types of investment portfolios are comprised of conservative, balanced, growth, and aggressive growth strategies. Younger investors often invest in riskier strategies because they have a longer investment horizon.
A good rule of thumb is to have a higher percentage of low-risk investments such as bonds if you are new to investing.
If you don’t already have an investment basket, you can build an investment portfolio using an investment platform (like Alinea Invest!). Within your portfolio, you can invest in stocks for companies you are familiar with and care about, along with other types of investments such as exchange-traded funds (ETFs) and government bonds.
Based on your investing approach, decide your portfolio’s asset breakdown. To mitigate risk, ensure a good mix of stocks, bonds, and short-term investments in your portfolio. Limit the total number of investments to keep things manageable.
Your job’s not done even after you have built your investment portfolio. Due to market fluctuations and changes in investment horizons, it is important to periodically monitor and re-balance your portfolio.
Whether by yourself or with the help of a financial advisor, evaluate your investment portfolio’s performance regularly and make adjustments as needed. One approach is dollar-cost averaging (DCA) in which you invest equal amounts over regular time intervals to reduce the impact of volatility on your portfolio.
In order to make the most of investing, an investor must balance risk and reward. Diversifying one’s portfolio can help reduce risk, and may, in several instances, even lead to increased rewards.
Learn more at Alinea Invest. Happy Investing!
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