The Importance of Diversifying Your Portfolio

You make investments because you want your money to work for you. Having a secure portfolio provides a steady source of income and helps you meet your investment goals. The key to a secure portfolio is smartly diversifying its contents. Diversification can be carried out in a variety of ways, but has essentially the same goal: to reduce the impact of a single risk on your holdings.

The Logic of Diversification

While it may be tempting to invest all your funds in one promising stock, investing in multiple items has a higher probability of achieving consistent and stable returns. Your returns will always be higher than the lowest performing investment. This means that your investment will be always lower than your most profitable stock.

For-long term investments though, particularly those with a particular revenue goal in mind, it is wiser to let the ups and downs even out your risk. If your highest performing stock is stagnating, a stock that lost a lot of value previously may climb back up to its initial value – which shows as a net gain over that time period as far as your portfolio is concerned.

An entry-level investor need not diversify their options as much initially, but rather reinvest early profits in diversifying their portfolio over time. This strategy encourages growth as well as diversification.

Types of Investments

Diversification exists in two major axes – between types of investments and within investments. Some major types of investment are:

·         Stocks (index and mutual funds), Bonds, fixed income Cash Equivalents

·         Real Estate

·         Precious Metals

·         Equities

·         Fine Art, Wine, Collectables

Dimensions of Diversification

Besides diversifying your types of investment, another important component of diversification takes place within these types. You invest most of your money in stocks, for example, but diversify it between different companies or sectors. Dimensions of diversification include:

·         Sectors – technology, financial, resource extraction, etc

·         Within sector

·         Within type of investment

·         Domestic vs. Overseas

·         Asset Classes

Another way to diversify your portfolio is based on the financial considerations of the investments aside from their category. These factors are:

·         Length of investment

·         Risk level

For instance, you may choose to invest some money in bonds as they tend to be a safe investment. However, you could diversify your portfolio by also investing in a high-risk, high-yield start-up company.

Ultimately, you will want to make your investments based on smart information, but diversifying your portfolio will help you weather out many a storm and will increase your probability for higher overall profits.