Today we’ll touch on something that doesn’t get enough attention in the world of investing, and that’s the importance of having a diversified portfolio. It’s important to spread your wealth across many sectors in the stock markets, and even into commodities. We’ll show you examples of a diversified portfolio so you can see what that looks like.
What Will I Learn?
- What is Diversification in Investing?
- Diversification Investing Explained
- How Many Stocks Should You Invest In?
- Benefits of a Diversified Portfolio
- Disadvantages to a Diversified Portfolio
- The Bottom Line
What is Diversification in Investing?
You could call this a strategy, but it’s more like an approach or investing technique that allocates your money into different areas of commerce. Your investments can be spread across different industries, financial instruments, and even market sectors. This helps your portfolio suffer minimal losses by investing in different areas that would have different risk factors when market turbulence and economic climates change.
While you can’t guarantee you will save your investments from a loss, diversification is perhaps the most important technique to ensure long term financial success while drastically reducing your risk. Let’s break down how you can diversify your portfolio.
Diversification Investing Explained
Adam has a portfolio consisting largely of hospitality and travel stocks. During the pandemic, his stock portfolio included airlines, cruise ship operators, hotels, and other companies in the hospitality sector. The global pandemic largely affected his portfolio as all of these businesses ceased operations for a period of time. Adam had to sweat out the pandemic and watch his portfolio tank while other sectors, like online businesses, such as Amazon and Shopify, earned huge profits. Nobody could accurately predict how long the pandemic would affect travel restrictions, but the point here is that Adam had most of his eggs in one basket when he should have been investing in other sectors.
Proactively balancing your portfolio will reap huge rewards over time. Instead of looking at one sector and owning many companies inside of it, it’s much more wise of a move to look into many sectors and spread your investments around.
There are several ways you can diversify your portfolio, according to Investopedia.
Sector and Industry Investing
As we explained above, Adam was heavy into the travel and hospitality industry. In order to diversify for a pandemic, he should have invested in streaming services, companies like Netflix, and other media companies, to provide counter balance.
Diversifying Across Companies
While Adam didn’t create the best portfolio for a global pandemic, he did create a solid portfolio of diversified companies in one sector. Owning hotel stocks, cruise ship stocks, and airlines was a solid idea to spread his money out in the travel sector, and that’s a prime example of how someone could diversify across companies in one market sector.
Diversifying Across Asset Classes
Long time readers will know we’ve harped on diversifying investments among many different assets classes for quite a while. Real estate investing, commodities, and now cryptocurrency, are all great asset classes that can be utilized to minimize investment risk. And let’s not forget about something we STRONGLY believe in – precious metals. As one of the longest running forms of currency, precious metals are a hedge against inflation and can help your portfolio through economic turmoil. But don’t just take our word for it, get a free gold and silver investing guide from Goldco and find out for yourself.
Diversifying Across Borders
In today’s day and age, it’s easier than ever to invest across borders. You can invest in currency, property, and more. Imagine what a drastic tax law change would do to the U.S. Are you certain you want all of your investments to be tied to the U.S. economy?
Diversifying Across Time Frames
Don’t put all your investments into “long shots that may pay off in five or ten years.” That’s a very risky way to invest that could wreck your portfolio. Instead, choose lesser producing, short term liquid investments coupled with long term, stable investments, and then have a small portion of your portfolio into more high risk investments, if you have the appetite for high risk investing.
How Many Stocks Should You Invest In?
There isn’t a formula or investment guide that will ever tell you how many stocks you should have, however there is a very informative chart below with allocation percentages. Always use allocation amounts vs. a sheer number of investment vehicles.
- Real Estate – 10%
- Government Bonds – 12%
- Emerging Market Stocks – 4%
- Domestic Corporate Bonds – 15%
- International Stocks – 10%
- Cash – 3%
- Large Cap Domestics – 28%
- Small / Mid Cap Domestics – 18%
Of course, with any investment, there is always risk. The main types of risk are:
- Systematic (market)
We won’t get too far into risk in this article, but we’ll link out to updates when we talk more about market risk.
Benefits of a Diversified Portfolio
A diversified portfolio is set up in a way to protect vs. potential losses. If you are nearing retirement age, this is something that needs to be a focus. It’s also important for anyone who is getting near the age of retirement but who will perhaps no longer have the same income, as they will need to have their portfolio be intact when it comes time to retire. Risk needs to be addressed as the risk tolerance won’t be as large as it was in years past.
Investing money across multiple industries and asset classes is a great way to create a broad portfolio that will have a better chance to survive market volatility.
Disadvantages to a Diversified Portfolio
In the end, not all asset classes have the same liquidity or potential upside. For example, a house purchased as an AirBnb rental in Costa Rica will not be as liquid as a rental income home purchased in the USA. It’s just a different buyers pool and the liquidity is greatly affected in this example. While it was wise to invest offshore, the liquidity is an issue.
Also, there are no guarantees. While it is wise to invest in all asset classes and even abroad, sometimes it STILL doesn’t work out. However, we’d urge you to diversify your portfolio vs. not diversifying your portfolio any day of the week, and twice on Tuesday!
The Bottom Line
By creating a diversified portfolio, you can manage risk and reduce the chances of losing everything based on swift market movements. While you can never eliminate risk, you can drastically reduce it by having a diversified portfolio.