9 Portfolio Diversification Strategies Used by Every Shrewd Investor
The number of millionaires in the US continues to rise by the year, and we currently have almost 22 million of them in the US. The thing is, investing is by far one of the surest ways to join this league and become a millionaire. However, it’s an almost impossible feat without diversification.
No matter how shrewd an investor you may be, you’re taking a risk if you don’t have a diversified portfolio. Diversification is one of the most important aspects of investing, and according to research, it’s the number one predictor of investment success.
There are many diversification strategies, and in this blog post, we’ll explore nine of the most pre-eminent ones used by savvy investors.
Table of Contents
1. Diversify Across Asset Classes
The first step to diversifying your portfolio is to invest in different asset classes. This strategy is also known as non-correlation, and it involves investing in assets that don’t move in the same direction.
For example, if you have all your eggs in one basket and that basket is the stock market, you’re taking a considerable risk. When the stock market crashes, so does your portfolio value. However, when you diversify by asset class and include other investments like bonds, real estate, and commodities, you mitigate the risk.
2. Diversify by Investment Type
This strategy involves investing in different types of investments within the same asset class. For example, if you’re investing in stocks, you can diversify by investing in small-cap stocks, mid-cap stocks, and large-cap stocks.
This way, even if one type of stock performs poorly, the other types may perform well and offset the loss. Moreover, different types of stocks tend to have different risk levels, so this strategy also helps you manage your overall risk.
3. Diversify By Industry
This is one of the best diversification strategies also known as sector rotation and involves investing in different industries at different times. The idea here is to spread your investment risk across different sectors so that if one industry is struggling, another might be doing well and offset some of the losses.
This strategy can be challenging to implement on your own, which is why many investors choose to invest in sector-specific mutual funds or ETFs. This allows you to get the diversification benefits of this strategy without having to constantly keep an eye on different industries.
Furthermore, many sector-specific funds are managed by professionals who have in-depth knowledge about the industries they invest in.
4. Diversify by Geography
Just as you would diversify your investments across different sectors, it’s vital to also invest in different geographical areas.
It’s easier to minimize the risk associated with any one particular region. For example, if you only invest in stocks from the United States, you’re essentially putting all of your eggs in one basket.
However, if you diversify and include investments from Europe, Asia, and other parts of the world, you’ll be better prepared for whatever market conditions may arise. According to research, the best way to diversify geographically is to invest in both developed markets and emerging markets.
5. Diversify by Investment Style
This strategy involves investing in both growth stocks and value stocks. Growth stocks are those of companies expected to grow at a faster rate than the market. Value stocks, on the other hand, are stocks of companies that are undervalued by the market.
The idea behind this diversification strategy is that growth stocks tend to outperform the market in bull markets and value stocks tend to outperform the market in bear markets. Smart investors investing in both types of stocks, can minimize your risk and increase returns.
6. Invest in Alternative Assets
If you’re looking for even more portfolio diversification, consider investing in alternatives. These investments don’t fall into the traditional asset categories of stocks, bonds, and cash. Instead, they may include things like real estate, private equity, hedge funds, and commodities.
Given that they tend to be less correlated with the stock market, they can help reduce overall portfolio risk.
Now, as a smart investor, remember that alternative investments are not suitable for everyone. If you’re going to add them to your portfolio, make sure you understand the risks involved and only invest money you can afford to lose.
7. Use Dollar-Cost Averaging
This technique involves investing a fixed sum of cash into security or securities at fixed intervals. By buying more units when prices are low and fewer units when prices are high, dollar-cost averaging smooths out the effects of price volatility on the overall cost of your investment.
Such diversification strategies can be especially helpful for investors who are uncomfortable with the idea of buying into a volatile market. By investing small amounts regularly, you can take advantage of lower prices while still buying into the market as a whole.
8. Review Your Portfolio Regularly
No matter what diversification strategies you choose, it’s essential to review your portfolio regularly. This will help ensure that your investments align with your goals and that your overall risk tolerance hasn’t changed.
Most smart investors review their portfolios at least once a year. That said, if you’re approaching retirement or have other major financial goals, you may need to do so more frequently.
Additionally, if there are any significant changes in the markets, you should always take a look at your portfolio to see how it has been affected.
9. Rebalance Your Portfolio
Over time, the different asset classes in your portfolio will likely experience different rates of return. This can cause your original investment mix to become unbalanced.
For example, if you started with a 60/40 stock/bond portfolio but the stock market had a great year, your portfolio may now be 70/30.
Rebalancing involves selling some of the assets that have done well and using the proceeds to buy more of the assets that have not performed as well. This helps you maintain your desired level of risk and keep your portfolio diversified.
The Best Portfolio Diversification Strategies
Diversification is an integral part of any investment strategy. By investing in various asset types, you get an opportunity for lower investment risk. You, therefore, maximize your chances of achieving your financial goals.
So, if you’re looking to diversify your portfolio, consider using one or more of the diversification strategies described above. Remember to review your investments regularly to make sure they remain in line with your goals.
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