Are you familiar with the phrase ‘don’t put all your eggs in one basket’? It can be applied to farming, relationships and many other aspects of life – including investing. It’s a basic principle of financial risk management and advises you to avoid concentrating all your money on one asset or category of investments.
This is because you risk setting yourself up for significant losses if this asset or group of assets depreciates. Instead, spreading your investments out – or ‘diversifying your portfolio’ as it’s known in trading circles – allows you to reduce your risk exposure, and build greater returns.
The theory is that by investing in different markets, industries, countries and risk profiles, you’ll earn higher profits, while your portfolio will be less vulnerable to volatility. You’ll also be better placed should any more major market shifts occur – like the COVID-19 pandemic, which triggered historically large and rapid declines in share values.
So how can you go about spreading your risk?
Choose different sectors
It’s tempting to stick with stocks in a company, sector or industry that you know well, like technology or energy for example. You might trust their reputation or even use their products and services.
However, investing in different sectors that aren’t closely related to each other can help you avoid disaster if one takes a hit due to economic slowdown or new government regulations.
Many experts advise investing in between 20-30 stocks. If you go much higher than this, you could struggle to keep up without devoting serious time and resources.
Explore different assets
An investment portfolio does not just have to consist of stocks. Many modern trading platforms allow you to explore bonds, forex, commodities, cryptocurrency and more, all from within a single account, and each has its own set of risks and opportunities. The basic idea is the same – by investing in different asset classes, you can increase returns and spread the risk.
Understand different investment strategies
There are a wealth of financial instruments and investment strategies available to investors, but it is critical that you fully understand all the possible risks of any such opportunities before you choose to invest your capital.
Traditional buy-and-hold investing, where you buy an asset and hold onto it in the anticipation that it might grow in value, is the mostly widely understood. However, it is also possible to invest in a wealth of derivative products, which can give you access to a wide variety of different assets, and spread betting, which allows you to speculate on the price of many markets at once.
Keep looking for new opportunities
All good investors keep their ears close to the ground. Alongside your steady, low-risk investments, stay on the lookout for new opportunities like booming businesses or sectors.
One recent example is the video conferencing software Zoom, which exploded during the pandemic due to our collective shift to remote working.
Diversifying isn’t as simple as just investing in different assets and markets and hoping for the best. It could actually hurt your portfolio’s potential if you add a new investment that increases risk or lowers your returns.
You might fall into this trap if you already have a strong portfolio, or if you add too many closely correlated investments. Do your due diligence on each move to avoid over diversifying.
This article is for informational purposes only. You should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained in this article constitutes a solicitation, recommendation, or endorsement of any financial product or service.