You must have probably heard an idiom, “Don’t put all your eggs in one basket”. If someone advises you to diversify your investment portfolio, then it essentially means spreading your investments between different shares, bonds, markets, property, commodities and so on in an attempt to minimize the overall risk.
It makes a great sense to go for a portfolio diversification because different types of assets like bonds, stocks, commodities, etc tend to respond differently because of the certain events or conditions like election results, interest rates, rising inflation and lots more. If anyone assets lose its value, then there is a high percentage of chance that the other assets in your investment or stock portfolio may perform better and balance out the loss suffered.
Investing in the shares from small and mid-cap companies or emerging markets increases growth possibility and help in managing the potential risks. For instance, if you have the shares of both the technology and health sector in your portfolio, then if shares of the technology sector are not performing well, but the health sector could be surging and this helps to offset the losses in your portfolio. This is why diversification becomes all the more important.
Why Portfolio Diversification is Important?
Minimizing risk of loss: If you are investing all your money in one sector, then your risk level is far higher. Investing in different assets or sectors ensure that if one sector is performing poorly, then the other investments may perform better, thereby minimizing the potential risks or losses. By diversifying, you are only spreading your funds and not risking everything. It is important to note that the investment portfolio diversification will not safeguard you from the general market slowdown, but it will certainly help you a lot to maintain the stability of the portfolio.
Wide asset choices: When your investments are diversified, then it means that you can spread them in various assets that include stocks, real estate, cash, bond, etc. Each of these assets has different aspects in terms of risk and profitability. Maintaining these assets helps a lot in creating a stable portfolio that may increase in value over a certain period of time.
Avoiding losses due to bad timing: Going for a portfolio diversification ensures that you have invested in the long-term benefits. Most of the investors get influenced by the market movements and tend to take the emotional decisions instead of following a disciplined investing approach. Many people enter invest in the shares when the market is performing well and panic when they see the prices of their shares going down. In such a situation, they sometimes take a decision to sell the under-performing shares. It leads to the investment portfolio generate the lower returns when compared with the market average. Maintaining a financial discipline in your portfolio pays off and goes a long way in balancing out any loss cropping up in the long-term.
Gain a better understanding of the market: When you diversify the portfolio, then your chances of becoming a knowledgeable investor or trader increases significantly. By diversifying in various markets, you will gain a better understanding of the economy and what makes your shares move. Your knowledgeable base is only increasing and this will help you out to come up with the new investment ideas. One thing is pretty much clear the market will always remain volatile and by diversifying, you keep yourself one step ahead in the stock market.
How Many Stocks are Enough in a Diversified Portfolio?
Now that we have discussed the importance or benefits of a diversified portfolio, a question may crop up in your mind as how much stock you should have in a diversified portfolio to achieve your financial goals. In general, it is quite a difficult task to come with the right answer to the above question, but most of the financial advisors or stockbrokers have provided the two main solutions:
- The minimum shares of different industries that you must have in your portfolio are 3-4.
- The maximum shares of different industries that you must have in your portfolio must not be more than 10.
When Diversify Investment Portfolio?
This is another very important question that most of the people fail to answer because of a lack of knowledge or clarity. When you a planning to diversify your stock investment portfolio, then it is important to understand that timing plays a big role in it. If you are investing in any asset for a time period of more than 15 years that is for your retirement or kids education, then you can hold on to that asset because the time gap is quite long. However, if only 5-8 years are remaining in your retirement, then it makes a great sense to diversify your portfolio and meet your financial objectives.
With stock market volatility to continue, planning to diversify investment portfolio is one of the best ways to navigate smoothly whatever the market brings. Regardless of your financial goals and risk tolerance, diversification can prove as an excellent base for a smart investment strategy to maintain the strong and well-balanced portfolio.