Diversifying your portfolio follows the basic advice of ‘don’t put all your eggs in one basket’. If you diversify you mitigate risk and prevent you from losing money.
You can diversify across assets and different asset classes. Diversifying your assets includes investing in a range of shares or ETFs. There are many different investment types to diversify your portfolio with: bonds, property, art, crowdfunding shares, P2P lending, and cash. You can also consider diversifying across industries and national economies by investing in companies from different countries and categories.
Diversifying is the best way to guard against risk. There are two types of risk you need to be aware of:
- Specific risk: the risk in investing in any particular asset which includes: competition, company success, and industry conditions. You can gain an understanding of the level of specific risk by analysing the past volatility of that particular stock or the industry as a whole.
- Systematic risk: the risk to a market, asset class or financial system. This is the downturn in the stock market, recessions or depressions. These tend to be more general movements in the economy.
Diversification protects against specific risk by reducing your exposure to a particular stock or industry and reduces vulnerability to problems companies and industries can face.
In downtimes diversification is even more important as you are protecting yourself from fragile industries and companies that will go bust. Systematic risk also induces less dramatic market downturns, where diversification can insulate you from risky companies that may bring large losses.
How to diversify
It is as simple as spreading your investments across a number of different shares. If you want to go the extra mile you could measure your risk and appropriately mitigate against it by following these targets:
- Limit each stock to holding more than 10% of your portfolio
- Invest in at least 15 different stocks
- Invest in at least 2 ETFs
- Invest across at least 5 different industries
- Spread your investments across the globe
- Invest in at least 1 alternative
You can do some research and decide which industries and countries carry the highest risk so you can include these as part of your portfolio, but make sure to limit how much investment you weigh on the most vulnerable of assets. It can be tempting to invest more heavily in an industry you are familiar with or has high potential such as green energy or emerging tech companies, but even these will carry their own risk and potentially earn you great losses. Perhaps the UK cuts funding for green technology or maybe a change in data privacy laws limits the growth of some tech companies.
You should build a portfolio of stocks which are different in a variety of ways: industry, company growth stage, country and reliance.
A great way to diversify your portfolio if you are unsure how to pick specific shares is investing in an ETF which provides you with diversification across a whole stock index like the FTSE 100 or the S&P 500. You can put the bulk of your investment into ETFs and reserve a portion of your funds for investing in riskier but potentially more profitable individual stocks.
Diversifying to reduce systematic risk can include investing in different asset classes. Asserting control and being smart by diversifying will preserve your portfolio and mitigate against risk over time. Why not learn to invest risk-free with BullBear.
This is not investment advice and should only be used as research and entertainment purposes only. All investors should make their own decisions and take on their own risks. If in doubt speak to a professional investment advisor.