The saying that has become very familiar in the investment world, that it is not a good idea to put all your eggs in one basket, well encapsulates the core idea of diversification.
Through diversification, investors can reduce their own risk of losing all invested funds, for example, if one company fails.
The idea behind diversification is that good and bad times can happen at different times and places in different investments. It therefore brings a good balance to the portfolio, although there is no such thing as a completely risk-free return.
With diversification, you can get as close to that as possible, which is why it is said that diversification is an investor’s only free lunch. However, it is worth remembering that whether it is an online casino or investing, neither should involve investing funds that you are not prepared to lose. There is always a risk – even a small one.
So how should you diversify your investments? In this article, we give you the best tips for diversifying your investments!
5 good tips for diversifying your investments
What should you invest in? There is no single right answer to this, as when making investment decisions, you should also take into account what you already have in your investment portfolio .
Here are five important points about diversification that you should keep in mind when you start investing:
1) Diversification into different asset classes
The expected return on your investment portfolio will largely depend on how much money you invest in different asset classes .
Different asset classes include, for example :
- Real estate
- Corporate loans
- Government bonds
- Raw materials
- Cash
- Stocks
All of these behave slightly differently . For example, when the stock market is down, precious metals and government bonds with good credit ratings perform well. Also, stock market cycles are shorter compared to real estate cycles .
An investor can greatly reduce their own maximum losses and smooth out the accumulation of returns by building their own investment portfolio from a wide range of asset classes .
With a well-constructed, high-quality investment portfolio, you can also effectively utilize market downward trends and thereby lower the average purchase prices of your own investments, for example.
2) Diversification across asset classes
Diversification across asset classes is important, but it is also important to diversify within a given asset class . This reduces risks and other threats related to, for example, a single company, sector or country.
The most important thing when investing in stocks is diversification within asset classes .
When investing in just one individual company, you are always exposed to, for example:
- For a change in corporate management
- The effects of political decisions
- For natural disasters
- Changing consumer behavior
- For other unforeseen factors
And if you’re really unlucky, a single company can collapse completely, resulting in a loss of -100%.
The easiest way to diversify risk across different asset classes is to buy an ETF , which at best can invest in up to hundreds of bonds or stocks.
In this case, those famous eggs are not in just one basket, meaning that the collapse of one company does not cause the entire invested funds to melt away.
3) Regular portfolio rebalancing
The idea behind portfolio balancing, or rebalancing, is to rebalance the portfolio to the target weighting at regular intervals . This can happen, for example, annually or quarterly, but it is not necessarily worth doing it more frequently than this.
How does rebalancing work in practice? Here are some guidelines for rebalancing your portfolio :
- For example, if you have 10 different companies in your portfolio, rebalancing means that each stock has a weight of 10%. If the weight is higher, you need to sell the stock, while if it is lower, you need to buy more.
- Another good way is to sell the share for the amount you invested in it yourself and let the proceeds do their job. For example, if you bought a share for 500 euros and it grows to 1,000 euros, sell that share for 500 euros. In this case, you have got your own funds back and can invest them in something else without having to give up the previous share.
- Most of the time, portfolio rebalancing can be done without having to sell anything. This is also more tax efficient. For example, a monthly saver can focus on funds that have a lower weighting than others or that are less than desired. A dividend investor can invest the dividends they receive in stocks that they would like to have a higher weighting.
By balancing your portfolio, you can easily avoid putting too many eggs in one basket . At the same time, you can automatically buy cheaper stocks in a bear market, but you can also sell expensive stocks in a bull market.
This way, you can achieve a better outcome than most other investors without taking a lot of risk.
4) Temporal dispersion
Time diversification is something to keep in mind, especially when you’re starting your own investment journey. In practice, it means buying investments at regular intervals , rather than pushing all your extra money into the market at once.
In the long term, the expected return has always been positive regardless of the starting point . In the short term, however, the purchase may take place at the top of the market, in which case it may take up to many years to recover from a sharp decline.
When investing large lump sums, such as an inheritance, savings accounts, winnings or even a gift, it is a good idea to divide the amount to be invested into several smaller parts . If the amount is very large, it is a good idea to spread it over 2-3 years, for example.
The easiest way to diversify your portfolio over time to reduce risk is to invest regularly . For example, put a portion of your salary into investments each month or invest a certain amount every quarter. This way, your portfolio will end up buying stocks in both uptrends and downtrends.
5) Stick to the big lines
In practice, it is sufficient to have a portfolio diversified to an accuracy of about 10% . A deviation of one or two percent in one direction or the other will not significantly affect returns, even if you think you can predict the future direction of the market.