Why Diversification Matters for Your Portfolio

Why Diversification Matters for Your Portfolio

Diversification is a technique that reduces risk by allocating investments among various financial asset classes. The idea behind diversification is that the positive performance of one investment balances out the negative performance of another in your portfolio.  When it comes to investing, portfolio diversification is essential. Without it, you risk losing everything if one investment or market crashes. Here, we discuss three different ways of ensuring your investment portfolio is diversified 

1. Ensure your portfolio has various financial instruments

An obvious way to diversify your investment portfolio would simply be to buy investments that span different financial instruments – some stocks, some currencies, and perhaps a position in one or more commodities. If you’re looking for an effortless way to do this, then consider purchasing ETFs. ETFs act as a basket of different stocks and can give you instant diversification because they operate on a diverse portfolio (a single ETF gives you exposure to multiple equities and market segments), so you don’t have to worry about the risk associated with one stock affecting your entire portfolio.
2. Consider investments with varying risk

When diversifying your portfolio, pick different investments because each asset class (such as stock, commodities, indices, etc.) is expected to reflect different risk and return investment rates and perform differently in any given market environment. By doing so, you make sure that gains for certain investment offset losses in other investments. Remember, even if your intention is to lower risk, don’t restrict your investment to blue-chip stocks only.

3. Rebalance your portfolio regularly

Contrary to popular belief, diversification isn’t a one-time task. Once you have a target asset allocation you need to keep it on track with periodic rebalancing. There’s no “set it and forget it” approach when it comes to trading. Rebalancing is the process of buying and selling assets over time to maintain a desired asset allocation, and here’s why it’s important. Portfolio drift often causes your asset allocation to shift away from your target, however, regular rebalancing not only helps keep your portfolio aligned with your target allocation, but it also adds to your long-term returns.


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