It’s important to diversify your portfolio if you want to be an effective trader- putting all your eggs in one basket with your investments could result in big losses if the asset or company you choose ends up suffering on the stock market, and widening your investment net could land you some unexpected boons while decreasing your exposure to risk. But what does diversifying your portfolio mean, and what are the best ways to go about doing that? Read on to find out more.
Invest in mutual funds and ETFs
If you want to tailor your investments more, you could consider using a mix of mutual funds and exchange-traded funds (ETFs) as part of your portfolio diversification.
A mutual fund is an investment vehicle consisting of a portfolio of stocks, bonds, or other securities. Mutual funds are operated by professional money managers, who allocate the fund’s assets to produce capital gains or income for investors. A mutual fund’s portfolio is structured and maintained to match the investment objectives stated in its prospectus. Investing in mutual funds can be a useful way to diversify your portfolio, and has the benefit of being less volatile than other types of investment.
An ETF is a type of investment fund that can be traded on an exchange, much like a stock. ETFs are similar to mutual funds in that both are investment funds, but where ETFs are bought and sold throughout the trading day, mutual funds are not traded on an exchange and only trade once a day when the market closes.
ETFs allow investors to diversify their portfolios across industries quickly and easily, with a single ETF delivering the benefits of multiple baskets at once. You can find out more about the specifics of ETFs here.
Diversify by sector
The stock market is a multi-faceted and diverse site of trading, with 11 sectors classified under the Global Industry Classification Standard (GICS). The GICS contains 11 stock market sectors, which can be further delineated into 24 industry groups, 69 industries, and 158 sub-industries.
To diversify your portfolio effectively, you should consider investing across a number of sectors, keeping an eye on market trends as well as changes in the socio-political landscape to see which sectors are most in demand at any given time. You don’t need to put a finger in every pie, but it could be useful to focus on a wide variety of high-quality companies. You can find out more about the different sectors that trade on the stock market here.
Diversify by company size
Spreading your investments across sectors isn’t the only way you can organise your portfolio diversification- you should also consider investing in companies and bonds of various sizes or market caps, such as small-cap, mid-cap, and large-cap companies.
You should try and invest in stocks with different incomes, growth and market capitalisation among other metrics. When investing in things like bonds, consider bonds with different credit qualities, durations, and maturities.
Picking investments with different rates of return is also something to consider when diversifying your portfolio, to ensure substantial gains for certain investments offset losses in others.
Look into foreign stocks
Investors have a tendency to lean towards domestic securities, but it’s important to consider investments on a more global stage and add some international exposure to your portfolio. Stocks from other countries tend to perform a little differently, and could balance out a domestic-heavy investment portfolio.
Broadening your investment horizons beyond domestic securities can allow you to capitalise on financial and socio-political developments in other countries, and respond to market trends from a more global perspective, which can come in handy if the economy is faring worse at home.
Investing in different regions and countries can reduce the impact of stock market movements- you’re not just affected by the economic conditions of one country and one government’s economic policies, which can open up investment options for you to reduce the potential of risk.
Rebalance your portfolio regularly
Portfolio diversification is not a one-time task, and you should check your portfolio often and make changes accordingly when the risk level isn’t consistent with your trading strategies or long-term goals. To rebalance your portfolio, reallocate funds from investments that have outgrown their desired allocation to ones that have underperformed.
It’s important to stay current with your investments and keep an eye on any changes in overall market conditions. You’ll want to know what is happening to the companies you invest in, so you can tell when it’s time to cut your losses, sell and move on to your next investment.
Beware of over-diversifying
While diversifying your portfolio is an essential part of trading effectively, as with all things you can run the risk of diversifying too much, and spreading your funds out too far between too many assets.
Over-diversifying might not end up losing you much money, but it might hold back your capacity for growth, as you’ll have too many small proportions of your money in different investments to see much in the way of positive results. It’s usually recommended that you hold no more than 30 investments, be it shares or bonds. If you’re investing in funds you should invest in a maximum of 15 or 20.