How diverse is your portfolio? If you’re not sure, you’re not alone! According to a survey published by CNBC in 2019, only 42% of current investors actively claim that their investment portfolio is diversifying. More surprisingly, approximately one in four investors says they are unsure of what even investment diversification means.
This only points to the continuing need for investment education. At Gorilla Trades, we want all investors to make the right decisions for their portfolio. With that in mind, we’ll explain a little more about how to pursue diversification.
What is diversification?
Just like you never put all your eggs in one basket, you should never put all your money into any investment.
No matter how well you investigate an individual action, you will never be able to be fully prepared for market fluctuations or the bankruptcy of a company.
For this reason, investment experts recommend that you distribute your money evenly across multiple assets. By doing so, you can protect yourself from risk, as the success of your other investments can provide a bit of safety net if one of your actions suddenly plummets.
How does diversification protect investors?
In general, there are two types of risk that can affect investors. Systematic risk (or “market risk”) refers to broad structural changes in the market, often caused by significant changes in investor behavior or by broader events such as natural disasters or war.
This means that all the assets you have can be affected, even the value of your cash can be affected by inflation.
How can investors be protected from such risks? By diversifying investments into various asset classes (cash, stocks, bonds), investors may find some protection against important events. For example, if your entire stock market crashes, a savings account full of cash keeps you from losing everything.
Non-systematic risk (or “asset-specific risk”) is probably the risk that is most often considered when investing diversification. This refers to significant fluctuations in the share price as well as the overall performance of the company.
Each time you invest in individual stocks, your potential return is directly related to the performance of that company.
When diversifying your portfolio, you are basically looking to balance the risks associated with a particular company with the potential benefits.
In other words, the more stocks you have in your investment portfolio, the less you will “feel” the impact if one of them suddenly decreases in value.
Similarly, the more shares you have, the more likely you are to benefit if one of them takes off at once. Diversification is about finding the right balance between risk and reward, which is why it is a long-term investment strategy.
How many stocks do I need to diversify my portfolio?
This raises an important question: how many stocks make up a diversified portfolio? There really isn’t a “correct” answer to this question. It often depends on your investment goals and your level of familiarity with the market.
If you are not investing in investments, you may have difficulty investing in a large number of stocks immediately, even if you are investing through a diversified mutual fund.
That said, financial experts generally agree that investors should target between 20 and 30 shares in their portfolios. Some would even say that after 30 shares, investors don’t see much benefit from diversification.
How to achieve diversification by asset class
There are three general types of asset classes that you can use to create an investment portfolio:
Bonds are similar to stocks. Instead of investing directly in the business, however, you should lend money to a business or government in exchange for an interest payment. This can make bonds a little more reliable (as long as the company is healthy), although returns tend to be more modest compared to stocks.
This is not to say that your investment strategy cannot include other investments such as real estate or precious metals or valuable commodities such as art.
Some investors are also putting their hopes in things like Bitcoin, though it’s not entirely clear how the cryptocurrency will evolve in the long run.
The point is, diversifying your asset classes can protect you if one of your assets falls off suddenly. For example, if your stock suddenly drops, you won’t have lost everything as long as you have money tied to a savings account or a piece of real estate.
Diversifying your investments can ensure that your overall financial position is protected from events that affect any type of asset.
How to achieve the diversification of your stock portfolio
Most investors are concerned about diversification when it comes to investing in the stock market. There are three basic ways to do this. Ideally, investors should try to incorporate all three strategies while making investments.
Diversifying means more than buying shares of many different companies. Investors should also ensure that these companies operate in different industries or sectors of the stock market.
For example, Apple and Microsoft belong to the technology sector, while Coca-Cola belongs to the basic consumer sector. Diversification requires you to invest not only in several companies, but in several sectors.
In addition, you will want to pay attention to the sectors affected by a specific economic cycle. Some companies (such as clothing, real estate, and financial services) will be affected by the nation’s global economic cycle, meaning that the success of these companies is based on global consumer demand.
On the other hand, basic consumers of stocks, utilities and health will be largely independent of economic trends, which means they can provide more stability. A well-balanced portfolio will include stocks of each type.
Actions aimed at growth and value
Investors should seek to acquire growth- and value-oriented stocks. Growth stocks are expected to increase in the near future. Growth stocks can be costly, but if the company performs well, investors can expect high returns.
Value shares represent companies that are currently undervalued or priced lower. Investors may be able to get a good deal on a stock when it is offered at a low price and then reap the benefits if the stock is to be repaid.
What is market capitalization? Market capitalization refers to the total value of a company’s shares.
You can calculate the market limit by multiplying the current share price by the total number of shares. In other words, the market limit tells you how big a company is.
To diversify your portfolio, you need to invest in companies of different sizes. Larger companies may offer more stability in times of financial uncertainty, but small and medium-sized companies may offer greater growth potential.
How can new investors diversify their portfolios?
For new investors, few things are as important as diversifying their stock portfolios. But if experts recommend a minimum of 20 shares, it can be a high order. However, there are several ways to achieve this feat. The one you choose may depend on your individual investment style.
Mutual funds, ETFs and index
Shares do not have to be bought individually. They can also be purchased as a collection through an investment fund, an index fund or through exchange traded funds (ETFs).
These options can quickly provide you with a diversified portfolio without having to do a lot of your own research. Even current investment applications can provide “advisors” to help you in the process.
Creating a mutual fund doesn’t stop you from making adjustments as you go along, either to add stocks to your portfolio or to abandon lower-yielding assets.
The great advantage of this type of fund is that your financial intermediary can help you a lot. If you are not comfortable with stock research and tracking their performance, a brokerage firm can provide you with help, as long as you are willing to pay a brokerage commission.
Target date background
Targeted funds are used when you want to collect your assets on a specific date. This makes them ideal for use as retirement accounts.
These funds rely on a fund manager to actively manage your portfolio, which can make them a little more expensive than other investment vehicles. However, they can be a good option for people who prefer to let their assets be managed by a professional.
Some brokerage firms will allow you to buy split shares in a company. For example, you may want to buy only 50% of a company’s shares. The money saved by buying fractional shares can help you quickly develop a diversified portfolio without requiring a huge investment.
This approach can be a good way to get used to the process of researching and selecting your own stocks. There are several useful tools available for researching stock selections that will help you along the way.
Invest like a pro with Gorilla Trades
Investment diversification is not difficult to achieve as long as the right tools are available. This is where we come in! Gorilla Trades members have exclusive access to our library of tools and resources designed to help them maximize their investments.
Why not see it for yourself by signing up for our free no-obligation trial? Take the next 30 days to see what Gorilla Trades can offer and how you can move further on the path to financial success.
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