Investors are always advised never to put their eggs (investments) in one basket (security or market), and this is the central concept of diversification. To have a diversified portfolio, you need to have a look at the asset classes that have low or a negative correlation so that if one moves down, the other tends to counteract. When the market is booming, it seems almost impossible to sell a stock for any amount less than the price you bought it. However, since we can’t be sure of the market conditions (just like what is happening now), it is important to have a well-diversified portfolio in any market.
This short guide looks at diversification and the best ways to achieve it.
What is Diversification
Diversification is a management strategy that incorporates different investments into a single portfolio. The core idea behind diversification is that various investments will yield a higher return. It is based on the principle that investors will face a lower risk if they invest in different vehicles.
Ivy League Investment Diversification
Ivy League universities such as Harvard, Stanford, and Yale have come up with a formula for diversifying investments that seems to be commonly accepted among investors. Their allocation is based on these percentages;
- 35 Percent S Equity
- 28 Percent Bonds
- 15 Percent Foreign Equity
- 11 Percent Commodities
- 11 Percent real Estate
Ways to achieve diversification
- To achieving diversification you need to ensure your portfolio has different investments.
Any properly diversified investment portfolio should have the following;
- Exchange-traded funds
- Mutual funds
You need to purchase ETFs, mutual funds, or index funds. ETFs and mutual funds act as basket f different stocks and give you instant diversification.
Another excellent option is index funds as they include stocks that mirror a specific index – such as the S&P 500. Though diversification may be a little more limited with this type of fund, it is still a sound option to go for.
Diversify within individual types of investments
With this step, first, ensure you pick investments that have different rates of returns. Ensure you invest a decent amount to make the cost of trading worth. If you get a handful of stocks, you will be at risk. When investing in stocks, don’t put a lot of focus on a single stock or just a few stocks, but rather, different stocks in different sectors. It is also important to ensure you have stocks with mixed-income, market capitalization, growth, among other metrics.
Consider investing in varying risk
When you are diversifying your portfolio, pick different investments that have different rates of return. This is done to ensure that significant substantial gains for specific investments offset losses in other investments. A good way to go about it is to look for foreign stocks as stocks from other countries tend to perform a little different as compared to domestic ones.
Lastly, re-balance your portfolio regularly. Diversification is not a one-time task. You should check your portfolio often to ensure you make appropriate changes.