HOW TO BUILD A
DIVERSIFIED PORTFOLIO

Diversifying your portfolio can help minimize your investing risk and maximize your gains. There are various ways to build a  diversified portfolio, including investing in different asset classes, such as stocks, bonds and real estate, or investing in a range of industries, so that you’re not overly exposed to any one sector.

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Diversification can help you reduce the impact of market volatility and increase your chances of earning a steady and sustainable return on your investment.

Benefits of diversification 

Diversification is an important investment strategy that can offer many benefits to investors, including risk management, the potential of higher returns, and long-term stability. Let’s take a look at these in more detail:

1. Risk management: By investing in a wide range of assets across different markets and industries, investors can reduce the impact that any single investment has on their overall portfolio. If one investment or market performs poorly, the effect on their overall portfolio may be lessened because other investments in the portfolio may perform well.
2. Potential for higher returns: By investing in different markets and industries, investors can benefit from the growth and performance of different sectors. This can potentially lead to higher returns than if the investor had all of their funds invested in a single sector or asset class.
3. Long-term stability: While certain assets may have short-term volatility, a diverse portfolio can help smooth out these fluctuations over the long term.

Ways to diversify your portfolio 

There are a few different ways to diversify your portfolio, such as investing in different asset classes or purchasing stocks from geographically diverse companies. You could also consider the risk level and sector direction of your portfolio. You can focus on one method, or adopt a blend of all of them to achieve the portfolio allocation you want. 

Asset class

Asset classes are different categories of investments that have similar characteristics and behave similarly in the market. The main asset classes are equities, fixed income, cash and cash equivalents, and commodities.

Diversifying among asset classes involves investing in a mix of assets that behave differently in various market conditions. By having a mix of asset classes in your portfolio, you can spread the risk and potential reward. 

By diversifying your portfolio across asset classes, you reduce your overall risk and increase your chances of achieving better returns. Keep in mind varying market cycles and how each asset class may respond differently to economic shifts. 

Geographically 

Different regions and countries have their own unique economic and political forces at play that can impact the value of investments. Diversifying your portfolio geographically means investing in both domestic and international assets. 

One strategy to get international exposure is to invest in global funds or exchange-traded funds (ETFs) that have holdings in various countries. Another approach is to research and invest directly in companies from different regions. 

There are some key factors to keep in mind when investing internationally:

• Political and economic stability: A country with a history of civil unrest or shaky financial systems may not be the best option for a long-term investment strategy.
• Currency risk: Fluctuations in exchange rates can greatly impact the value of your investments.
• Regulatory risks: Regulations in foreign countries can be vastly different from regulations in your home country.
• Language, cultural and legal differences: This can add an additional layer of complexity or confusion when deciding to invest.

Industry or sector 

Another way to achieve diversification is to spread your investments across multiple industries and sectors. This means allocating your funds across several sectors, such as technology, energy, healthcare and real estate. 

By doing so, you can avoid concentration risk, or the impact of market fluctuations in one industry. If one industry experiences a setback, another may be thriving and can offset those losses.

It’s important to do your research and understand the risks and potential returns of each sector before investing. Make sure that you understand the correlation between industries and sectors and how they affect one another. 

Risk level

Diversifying your portfolio by risk level means spreading your investments across different types of assets with varying levels of risk. The percentage you choose to allocate to each depends largely on your investment goals and personal risk tolerance. 

For example, you may consider allocating some of your portfolio to high-risk, high-reward investments such as individual stocks while also including some low-risk, conservative investments such as bonds or cash.

Assessing your investment goals and risk tolerance

Your goals will determine the type of investments you choose, whether it’s short-term gains or long-term growth. Your risk tolerance will determine how much risk you’re willing to take on. 

Are you comfortable with the ups and downs of the stock market, or do you prefer safer, more stable investments? By understanding your investment goals and risk tolerance, you can create a plan that suits your needs and helps you achieve your financial goals.

Think about what you want to get out of investing — this will provide a blueprint for the type of investments you should be making. Investment goals could include saving for retirement, a down payment on a new home, or simply looking to build wealth over time.

Next, consider your risk tolerance, or the amount of risk you are willing to take on in your investments before it becomes uncomfortable. 

Determining your risk tolerance is not necessarily about being a risk-taker or playing it safe. It’s about understanding your own personality, goals and circumstances. There are several factors to consider when determining your risk tolerance, including: 

• Age
• Income level 
• Investment horizon

Maintaining diversification 

Investing is not a “one and done” activity. In order to keep things diversified, it’s important to periodically rebalance your assets to ensure that they’re still appropriate for your investment goals and risk tolerance. 

Maintaining diversification in your portfolio includes reassessing your asset allocation, tweaking your holdings, or even selling off some assets.

Additionally, monitoring your portfolio on an ongoing basis can help you spot trends or changes in the market that may have an impact on your investments.

By regularly rebalancing your portfolio, you can take advantage of market opportunities while staying true to your investment strategy. Just remember that a well-diversified portfolio can help reduce risk and, ultimately, lead to greater financial rewards.

Conclusion 

Diversification is the key to maintaining a stable and successful portfolio, and there are many ways to get there. 

By spreading your investments across various industries and asset classes, you can protect against the risk associated with any one particular sector. Investing in different types of assets can help to reduce the overall volatility of your portfolio and maximize your returns over time. 

Diversification also allows you to capitalize on different market trends and take advantage of emerging opportunities that may arise in the future. 

Learn more about diversifying your portfolio on the eToro Academy.

Quiz

FAQs

What assets should I buy to diversify my portfolio?

Diversifying a portfolio is primarily a numbers game. In general, the greater the number of different assets you invest in, the higher the chance that you’ll benefit from reduced risk and smoother returns.

Can it ever be a bad idea to diversify a portfolio?

A good investment plan usually has an end date, which is the time that you want your investments to mature. If you’re close to using your investment to finance a life goal, such as retirement, rotating out of riskier assets and allocating capital to bonds will reduce the likelihood of a market shock negatively impacting your plan at the last minute.

Are there easy ways to diversify my portfolio?

Some instruments, such as indices, Smart Portfolios and ETFs, are single products that hold a basket of different assets. For example, the ETF in the S&P 500 stock index contains small positions in each of the stocks of the largest companies listed on US exchanges. Although the S&P 500 represents an investment in a single asset class, it mitigates against single stock risk.