Here are 5 Ways You Can Diversify Your Financial Portfolio

The key to an efficient investment plan is the diversification of a portfolio. When you diversify investment, not only do you minimise the risk for long term savings, but you can also explore high-return investments with a reliable safety net to fall back on.

Let’s understand the importance of risk diversification and learn how to diversify your portfolio.

What is Risk Diversification?

The foundational thesis on which the concept of diversification of a portfolio is built is a common proverb: don’t put all your eggs in one basket.

The financial market is often unpredictable, and no one can tell with impeccable precision how it would behave at a given time. Considering this, the logic behind investment diversification becomes apparent — your chances of losing all your money at the same time are lessened when you invest in several things.

Here is a diversified portfolio example to help you understand the concept better:

In 2008 the S&P 500 experienced a negative return of 37.00%. This translated to an ending value of $63k on a $100k investment. Alternately, your ending value at the end of 2008 would have been roughly $84,120 if you had only put half of your money into the fixed income. This diversified portfolio example illustrates how a potential investor could mitigate the risk of losing all their funds.

When you diversify investment, your portfolio can absorb the shock of any financial disruption, thereby effectively balancing your saving plan. However, diversification of a portfolio is not limited to risk diversification for a single type of investment class or securities. It extends within the class of each security as well.

Now that you understand why you must diversify portfolio, let’s learn how to diversify your portfolio.

5 Effective Strategies for Investment Diversification

Efficient investment diversification becomes crucial to develop an investment strategy that tempers potential losses. Here are five strategies that can help diversify portfolio:

• Think beyond stocks and bonds for investment diversification

  Typically, when you think about how to diversify your portfolio, most people exclusively design a combination of bonds and stocks. There are, however, a lot of other elements that could be employed to diversify investment. These include mutual funds, managed accounts, infrastructure investment trusts (INVITS), real estate investment trusts (REITS), commodities, private equity, and venture debt. Investors could also consider non-financial assets such as real estate, gold, art, collectibles, etc.

• Use index funds to diversify portfolio

  It is a common misunderstanding that portfolio diversification requires a lot of funds. However, if you are looking to diversify your portfolio at a low cost, then index funds are a great starting point.
  By purchasing mutual funds or ETFs that track broad indexes, an investor can buy into a portfolio for almost nothing. This approach is also much simpler than developing a portfolio from scratch and analysing the industries that you are exposed to.
  Conversely, investors can add exposure to specific industries and sectors using their index funds, for a more active approach.

• Diversify portfolio by also using your cash

  Cash is often forgotten in diversification, but it offers security during market sell-offs despite inflation's value loss. Evaluating cash along with your investments reveals its role in sustaining your portfolio by decreasing less than the market in downturns. Moreover, cash allows seizing opportunities in a positive future financial landscape.

• Simplify diversification of a portfolio using target-date funds

  Target-date mutual funds enable you to pick a date in the future that is your investment goal - for most individuals, this is their retirement fund. When you are several years away from the goal, your funds are invested in riskier assets such as stocks. As you get closer to the goal, however, your funds are redirected to safer assets such as cash or bonds. This is a highly suitable approach for investors who are looking for a “set it and forget it” kind of investment strategy.

• Diversify investment by thinking global

  The global economy is presenting increasingly attractive opportunities for investments. Therefore, individuals who are seeking to diversify their portfolios can also explore emerging markets. This strategy also secures the financial portfolio against market fluctuations in one’s own country.
  Understanding how to diversify your portfolio helps you make informed financial decisions and take control of your financial future.

Conclusion

For securing your future and achieving your financial goals, it is essential that your portfolio factors in risk diversification. To help you stay on track with your investment goals, you must periodically review your investments to analyse the best and worst performers and balance your fund’s allocation accordingly.

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