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Why is it Important to Have a Diversified Portfolio?

by Invisor Last updated on March 21, 2018 Tags: Save Well

Photo by Orlova Maria on Unsplash

As an investor, one of the most important things you can do to make sure your savings are protected is to diversify your portfolio. A properly diversified portfolio is a simple way to reduce the impact of volatility and isolated risks, and ultimately, allow you to sleep better at night when it comes to thinking about your investments.

In this post, we’ll talk about how diversification can provide you with steady returns while protecting you from less-than-favourable market events.

What is portfolio diversification?

Diversification is an investing strategy that allows you to protect your savings and minimize bad risk to your portfolio. This is done by spreading your savings across various sectors, geographical regions, and asset classes rather than relying on just one or two (i.e. not putting all your eggs in one basket). When your assets are spread out across multiple types of securities with different characteristics, your portfolio is less likely to be negatively impacted when a single security is negatively impacted, since you’ll have other options in your portfolio.

This doesn’t mean that you totally eliminate risk in your portfolio, you merely reduce the amount or risk you take without giving up the potential for return.

Why is risk important for portfolio growth?

Risk may generally have a negative connotation, but the saying no risk, no reward rings true for investors. To receive a good return on our investments, we need to take on a certain amount of risk, whether it be a more conservative option, or a high-risk-high-reward approach. The more risk we take on, the more reward we can expect. And when we take on risk, we can also expect a certain amount of fluctuations.

Fluctuations are inevitable; think of the journey to your savings goal as more of a winding path than a straight climb to the top. But when we pair good risk with a diversified approach, we put ourselves in the best situation for weathering these fluctuations, reducing the sharp cliffs to more gradual slopes.

What is risk tolerance? And what is ‘good risk’?

How do I diversify my portfolio?

As we mentioned above, when it comes to investing you don’t want to put all your eggs in one basket. Diversifying your portfolio is all about allocating your assets in a way that spreads your money out across different securities that respond to isolated risks differently.

With all investment decisions, it’s important to first determine the amount of risk you can take so that you can create a top-down broad allocation strategy to different assets classes. Once you have that broad asset allocation strategy in place, you can diversify within it.

A well-diversified portfolio has a balanced weight across asset classes (equities, fixed income, cash, and commodities), geography, sectors (financials, utilities, consumer products, technology, etc.) and company size and type (large or small, value or growth). The simplest way to achieve this is to invest in index funds that don’t discriminate on holdings, and ensure your allocation closely follows broader global weights in each category.

Diversification is the best tool to have in your investment plan. It will keep you stable in rocky markets, minimize your risk, and ensure steady and consistent growth. If you’re unsure about how to properly diversify your portfolio and manage your risk, talk to an advisor who will be able to get you on the right track.

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