Diversification
Diversification is a risk management strategy that mitigates risk by allocating investments across different financial instruments, industries, and several other categories. One of the keys to successful investing is learning how to balance your comfort level with risk against your time horizon. A diversified investment portfolio is built with a variety of investments that have low correlation, with a different pattern of expected risks and returns. By choosing not to put all of your eggs in one basket, you protect your portfolio from market volatility. Most experienced investors agree that, although it does not provide any guarantee against loss, it is the most important component of achieving long-range financial goals while reducing risk.
ABOUT DIVERSIFICATION
Diversification involves spreading your money across a variety of investments and asset classes.
Diversification lowers your portfolio's risk because different asset classes do well at different times.
A diversified portfolio should include a mix of asset classes, diversification within asset classes, and adding foreign assets to your investment strategy.
Diversification can also be achieved by purchasing investments in different countries, industries, sizes of companies, or term lengths for income-generating investments.
HOW TO BUILD A DIVERSIFIED PORTFOLIO
Diversify across asset classes.
Having a mixture of equities (stocks), fixed income investments (bonds), cash and cash equivalents, and real assets including property can help you maintain a well-balanced portfolio.
Diversify within asset classes.
There are a few key ways to diversify within each asset class, including by industry. You can also diversify your fixed income investments by seeking out bonds with different maturities and from different issuers.
Invest globally.
Consider global exposure when building your portfolio to safeguard against country-specific risks. Foreign assets like stocks and bonds for companies in other countries can help you create a more well-rounded, diverse portfolio.
Perform a regular portfolio review.
You should rebalance your portfolio regularly to ensure you’re staying the course amid inevitable market highs and lows—and certain situations like major life events will trigger the need to rebalance, too.
DIVERSIFICATION MISTAKES TO AVOID
Diversifying excessively.
Sometimes too much of a good thing can be just that. Some investors, in an attempt to diversify, invest in too many funds with overlapping holdings, unnecessarily increasing investment costs.
Ignoring correlation.
True diversification means including assets that don't move in lockstep with one another.
Forgetting to rebalance.
A diversified portfolio needs regular maintenance. Without rebalancing, your portfolio could have an asset allocation that no longer matches your risk tolerance or investment goals.