The most crucial advice for every investor is to avoid putting all their eggs in one basket. This means you should not put all your investing resources in a single asset class. It is vital to mitigate risk when investing, and diversification is the best way to lower the risk.
Most investors might have only added one or two securities to their portfolio. When the market affects those securities, they lose a lot of money.
As an investor, it is recommended to periodically review your portfolio for better diversification. Let’s take a closer look.
What Is Diversification, and What Does It Entail?
Diversification involves investing in different asset classes and investments within an asset class to reduce the risk of your portfolio. It’s the most essential part of any investment plan because there’s no guarantee of what might happen.
By diversifying your portfolio, you spread the risk across different assets so that the rest can make up for it, even if one is underperforming. When looking at diversification, you might come across asset allocation, which shows how much of a portfolio is invested in different asset classes.
Most investors stick to stocks, bonds, and cash. However, to achieve diversification, investors should combine dissimilar assets like stocks and cryptocurrency so that the portfolio is not limited to a single asset class in the market sector.
For instance, if you only invest in a particular stock from a hospitality company, your asset allocation would be 100% stocks.
If the stock prices slump because of unforeseen circumstances, your portfolio will take a massive hit. Even if you buy other stocks, your portfolio will still be negatively affected if they are still in the hospitality sector.
You will need stocks from different sectors, bonds and fixed-income securities, real estate, forex trading, commodities, and cryptocurrencies to diversify. Doing this can protect your investments from volatility.
Types of Investments Beyond Stocks and Bonds
Alternative investments are any that aren’t stocks, bonds, or cash. These are very dissimilar and have a low correlation to traditional assets. So, even if the stock market is crashing, some of your alternative investments will perform well.
Real Estate
This involves investing capital in residential, commercial, or retail properties. It can be done directly or through a real estate investment trust.
Real estate is the most correlated to stocks among other alternative investments. But, it’s less volatile to invest in real estate, offering passive income and long-term appreciation.
Forex
Currencies and stocks usually move inversely, especially during a crisis. So, investing in forex as part of your portfolio is a good idea. Safe-haven currencies like the US dollar strengthen during adverse global events that otherwise affect stocks.
Commodities
Another option is commodities, where you invest in natural resources like oil, timber, or agricultural products. Precious metals like gold, silver, platinum, and palladium are popular. These are seen as stores of value that can protect the worth of your investment when stocks and bonds fail.
Cryptocurrencies
Most people have implemented cryptocurrencies in every aspect of their lives, from banking to regular purchases, and it can be an excellent way to diversify your investment portfolio, too.
Adding crypto to your portfolio can reduce volatility and risk, protecting your assets. Bitcoin also serves as a leading indicator, as significant moves in the stock market usually follow its increase. Other options include hedge funds, private equity, debt investing, structured products, and collectibles.
Diversification Strategies To Consider Implementing
The conservative way to diversify your portfolio is 60% stocks and 40% bonds. However, the investing industry has become more diverse, offering multiple options.
That’s why most investors consider the 5% rule. This rule states that 5% of your portfolio should be tied to a single security.
It involves having 20 securities in your portfolio, each taking 5%. If a company or cryptocurrency performs poorly, other aspects of your portfolio, like commodities or real estate, still hold up.
Individual Asset Diversification
The first option is to invest in a wide range of assets within an asset class. For instance, investing in different stocks from various industries or in other cryptocurrencies.
If you buy in the S&P 500 list, you get high and low-risk stocks from different sectors in your portfolio. However, it still limits you to stocks; if the market crashes, you lose everything.
Asset Class Diversification
Another option is investing in different asset classes, from traditional to alternative investments. Alternative investments will benefit investors since they complement traditional securities well. They often move in the opposite way of stocks and bonds or act as a store of value.
Tips for Diversifying Your Portfolio
Here are some tips that can be useful when diversifying your portfolio.
- Don’t limit yourself to stocks and bonds.
- Invest in target funds, which involve choosing a date and investing in higher-return assets.
- Use index funds like ETFs or mutual funds for better diversification.
- Regularly rebalance your portfolio to achieve your investment goals twice a year. Some strong performers will take more room, while you might have to remove the worst performance.
- Don’t neglect the importance of cash in your portfolio, which can be helpful in case of a market selloff.
- Although many investment options exist in the US, diversification, including international markets, should be considered.
Going Beyond Traditional Investments for Diversification
In the world of trading, there is always an uncertain future as things might not go as you expected or predicted using different tools. That’s where diversification comes in.
This practice protects your portfolio and foreign investments. Remember to review the portfolio a few times a year to stay on track with your long-term goals.
