Investing your money can seem like a daunting task. There are tons of different asset classes with varying risks associated with them. After all, regardless of how safe the asset is, there is still some risk of losing the money you put in. This is where great investment plans require a careful planning focussed on diversifying investment portfolio to balance risk and reward
So does this necessarily mean you should stay away from investing your money in different financial instruments?
Not at all! What this means is that you need to understand how to diversify your investment portfolio
It just means you should make an informed decision about your investment. Do extensive research and weigh all your options before making the final choice. You can significantly reduce the risk involved and ensure stable returns if you play your cards right.
It is important that you understand the financial world to make a secure investment decision. According to Lexington Law, over 50 percent of US citizens lack the basic understanding of financial markets. Without this knowledge, you cannot make the right decision about which stocks or bonds to invest in.
One way to make a secure investment is to diversify your investment portfolio. A diverse portfolio ensures that you don’t put all your eggs in one basket and hence reduce your risk.
Here are five things you must keep in mind when you want to diversify investment portfolio:
Spread Your Investment
A sector that is performing very well today might take a dip tomorrow.
One of the biggest mistakes people make when diversifying their portfolio is investing in stocks of different companies within the same sector, which has been performing well.
For example, according to Liberated Stock Trader, the tech sector has continued to be the fastest-growing industry, with over 25 percent increase in growth in 2019. This might motivate some to only invest in this sector.
However, you can never be confident about what the future may hold. Certain unforeseen circumstances can affect the industry, like the airline sector that has been severely impacted by COVID-19.
Therefore, it is always better to diversify your portfolio by investing in multiple industries, instruments, and commodities. This way, you will be able to effectively spread the risk involved, thereby reducing the chance of losing your money.
However, try not to go overboard with too much diversification. Keep it manageable. Don’t invest in 100 different instruments. Instead, choose across sectors and commodities, but keep it all limited.
Diversifying Investment Portfolio doesn’t necessarily mean variety
A common misconception people have is that merely having a variety of stocks is synonymous with owning a diversified portfolio.
This is not the case.
Instead, your variety should surpass the type of stocks and should also include different investment products and instruments. This includes ETFs, bonds, options, and cash equivalents, etc.
What benefit does this bring to your investment portfolio?
Well, every financial instrument has its share of benefits and downsides. They feature different rates of return, risk, interest rates, cost, and time horizons, etc. Therefore, to create the perfect portfolio with varying risk, investing in different types of financial instruments is a great way.
Certain investments, like in precious metal, remain stable in delivering returns even in the case of inflation. During high risk in equities, bonds seem like a better choice. And treasury bills give low returns but act as a great cushion.
By having the right proportion of a few of them, you can easily create the right portfolio. You can use portfolio management tools to help you with your research for assets to invest in.
One example is the Stock Scanner – Ziggma. It is a convenient and user-friendly tool that saves your time and effort. You can use it to research stocks, ETFs, and bonds. You simply set the parameters you want and get great investment opportunities in a split of seconds. It also has other useful tracking and analysis tools to help you optimize your portfolio.
Don’t stop at just one time investment portfolio diversification
Creating a portfolio should never be a one-time thing. Rather than investing $20,000 in one go in different assets, it is a much better idea to build up your portfolio gradually.
This way, you can learn from your initial mistakes, adapt to the market volatility, and boost your chances of reaping additional returns.
One way of investing that comes in handy here is ‘dollar-cost averaging.’ In this approach, the investment risk involved in the portfolio is spread across a time period.
It aids in smoothing out any disturbance your portfolio might experience due to systematic and unsystematic risk.
Go Global as a way to diversify investment portfolio
As the world we live in transforms into a ‘global village,’ many think that discrepancies between domestic and international assets have ceased to exist.
While this is true to some degree, still international markets tend to feature a different rate of gain and risk than the domestic market. It is because market conditions differ from country to country.
For starters, just because the country you live in is going through a recession doesn’t mean that the other countries will follow suit. Hence, adding international stocks and instruments in your portfolio is the best way to diversify it.
International diversification in your portfolio provides you with a blanket of varying currencies, economic conditions, and regulations. It saves you from the shock if the stock market of one country goes down.
Know when to divest
Sometimes even the most thought-out and researched portfolios fail to mitigate risk and deliver the required returns. Thus it is crucial to monitor the performance of each of the financial instruments within your portfolio.
Regardless of what strategy you use to stabilize it, ensure that you know when the market risks make your portfolio unstable. In such instances, it is best to divest and reinvest in other profitable stocks and bonds.
However, you cannot do so unless you are well-versed with the performance of your instruments. For this, you must keep tabs on the companies you have put money in. Monitor each stock and sell it at the right time to reduce your loss.
There is a wide variety of portfolio management schemes that you use in case you don’t have the time and resources to keep a close eye on each of your instruments.
Investing is an excellent way to secure your future, and having a diversified investment portfolio reduces the risks that come with investing money. If you keep the above five considerations in mind, you can easily create a portfolio that can give maximum returns on your investment.
Good luck with investing your money!
Andrea Bell is a blogger by choice. She loves to discover the world around her. She likes to share her discoveries, experiences and express herself through her blogs. You can find her on Twitter:@IM_AndreaBell