The Importance of Investment Portfolio Diversification
Investment portfolio diversification is a trial and error technique that involves reducing risk by spreading your investment across a variety of companies, sectors, geographical locations and assets. Just so you know, diversifying your investments is not an absolute buffer against financial losses. However, it remains a vital strategy for reducing the risk that often helps investors achieve their financial goals.
How does a diversified investment portfolio improve my chances of growth and success?
A diversified investment portfolio contains investments with low correlation to each other. This means that it has lesser risk of being heavily impacted upon by negative value fluctuations in any one company, sector, country or asset. A fall in the value of one investment will be cushioned by a rise in the value of another investment.
Here are the key ways you can diversify your investment portfolio:
- Diversify your company investments
It’s obviously common sense to not invest all your money into a single company. You have to wisely spread your investments across a number of companies and consider investing in companies that operate in different market sectors. It’s vital to conduct thorough research into any company you are interested in investing in and to seek the advice of an independent financial advisor prior to making a final decision. In the current economic climate, even the most prosperous of companies can suffer a fall in value.
- Diversify your sector investments
Investing in a range of different sectors brings the same advantages as investing in different companies. In the current economic climate there have been peaks and troughs in a wide range of sectors. To provide a cushion with your investment portfolio against your entire portfolio losing value, spread your investments across sectors with low correlation. For example, if your investment in a company within the education sector suddenly experiences a dip in value, a rise in your investment within another sector could compensate for it.
- Diversify the geographical locations of your investments
One of the good way to minimize the effect of stock market movement is to spread your investments across different countries and separate regions. It’s quite a risk to place all your faith in the economic stability of a single country and the financial policies of its ruling government. Hence, it is crucial to conduct research into the stock markets of different countries and get expert advice from an independent financial advisor before making any investment decision.
- Diversify your assets
It’s wise to have a good mix of varying asset types within your investment portfolio, as it spreads risk. There are many different types of assets, the primary types being shares and bonds, which often have a low correlation to each other. Hence, it is better to discuss with your independent financial advisor about the best way to mix the asset types within your investment portfolio as they will have more market knowledge and understand the risk throughout your portfolio. Investors are required to decide the level of risk that they are willing to take according to their financial goals. If you would like to be able to withdraw the money anytime in the short term, then you shall go for lesser risks. On the other hand, if you are young and planning to go for a long term investment strategy, then you may feel inclined to take greater risks.
Avoid over diversification
While diversification can protect your investment portfolio from the value fluctuations in correlated investments, over diversification can lead to you not having enough invested money in a company sector or sector to truly benefit from any growth. Again, it’s a case of planning your investment portfolio carefully with your financial advisor and striking the right balance.
