With so many ways to invest online, professional analysts and investment specialists often state that the best way to manage your investments is to spread them across various asset classes.
If you have only one investment, and it is in gold, if that sector takes a dip, then your entire net worth follows. However, if you have a mix of stocks, commodities and other investments, it helps to insulate you from the more damaging effects of a market downturn.
There are dozens of ways to strike a balance when diversifying your portfolio. For example, you can go for low-risk, small-return products such as savings bonds or opt for higher-risk assets such as cryptocurrency, the most volatile asset class you can invest in.
Components to consider
It’s all well and good to have the intention to diversify your portfolio but you must understand the market too. For instance, if you invest heavily in stocks but want to hedge against inflation or any market downturn, you could turn to gold investment, which is typical. But do you know enough about gold to put your money in there?
Diversification will help mitigate profound loss but you must strike a balance by investing in what you understand. A solid, diversified portfolio could include a few stocks, some forex and a little real estate. You don’t need to have 45 different investments littered all over the place across various asset classes, because that would defeat the purpose and end up being counterproductive.
Striking a balance is essential. You could operate primarily in stocks, and a diverse portfolio could be spread across oil companies, environmentally friendly companies, e-commerce and fashion. However, ESG investments look like they will become a part of your portfolio anyway, in some capacity.
Even though they’re in the same asset class, they are wildly different companies. One might perform better than the other irrespective of the economic sentiment, so it is also a personal approach that works for you at the end of the day. Consulting a financial investment specialist who can give you this information would be a smart move.
Other options apart from diversification
One of the most crucial components when investing is knowledge of the asset; we can’t stress this enough. If you believe you have a good investment at a reasonable price and are not using too much of your capital, then this strategy could work for you.
Theoretically, let’s say you’re eyeing a stock at $1.00 and it’s down from $2.00, where it was six months earlier. You believe they are soon to announce the news that they are expanding into another country, so this sounds like a good investment. On the flipside, you wouldn’t purchase $1,000 of cryptocurrency just to diversify your portfolio for the sake of it.
If your initial hunch and research have a better chance of paying dividends, stick to what you know and keep the process simple – investing isn’t a one-size-fits-all approach.
The benefits of a diverse portfolio
All great investors have a balance and a mix of different assets, indicating a safer strategy. If you diversify your portfolio, it shows that your general appetite for risk is diminished and that you are considering other market factors that are at play.
Other effective ways to manage risk and portfolio diversification include setting stop loss and take profit limits. You don’t want to be spend your time staring at charts, and if you have a selected entry and exit point, it is often best to stick to your initial plan.
Once you allow emotions to dictate the next move, you are on a slippery slope. Many investors and traders consider emotional trading the main reason people lose money in live markets. Balancing your portfolio helps manage emotion too.
For instance, if the cryptocurrency market plummets but you have 75% of your portfolio in stocks and commodities in profit, you will be less likely to make a decision that is based on negative emotion. It all depends on the level of your investment and how exposed you are to volatility, combined with your risk appetite.
While some investors will do well sticking to one asset class, it is often a surefire way to make a disastrous loss over a short period of a day or a week. Many trading horror stories begin with an investor completely focused on one industry – usually cryptocurrency – as many victims of the FTX collapse will testify.
However, by effectively managing this risk, you can use portfolio diversification to your advantage and ensure that any capital you use can travel further in a volatile market or during a market downturn.