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The reasons for investing are well known, but turning your capital into a functioning investment portfolio takes a degree of skill and a good amount of research. 

Building a diversified portfolio is widely considered one of the best routes for achieving financial independence and keeping things simple can often be advantageous. Deciding how much cash to allocate to different asset classes is one of the most important considerations that a new investor can make.


Diversifying a portfolio is about more than just buying lots of different instruments. It’s also about how those different assets complement each other and whether their price moves are likely to be correlated or not. Consider two of the most important factors when diversifying your portfolio: asset allocation and portfolio structure.

Diversifying Your Portfolio: A Step-by-Step Guide to Minimize Risk.

Tip: Asset allocation should be tailored to an individual’s circumstances. There are many variables to consider, including risk profile and investment experience, as well as your overall investment aims and time horizon.

What is asset allocation?

Asset allocation describes how an investor’s capital is used to buy different assets, such as stocks and bonds. This is often represented as a percentage of the total value of your investment portfolio, with the exact split depending on your individual circumstances and investment aims.

As long as you understand the potential risks attached to over- or under-allocating to certain assets, there is not necessarily a right or wrong way to go about this process. However, a 70/30 split between equities and bonds has traditionally been a good place for new investors to start. Having said this, the majority of your investment portfolio will hold medium- to high-risk assets, with the higher price volatility of stock positions being balanced out by fixed returns from lower risk bonds.

Tip: A rule of thumb when considering asset allocation is to subtract your age from 100 and use that number as a guide for what percentage of your portfolio should be in stocks. Usually, the older you are, the more lower risk assets you’ll own.

What is diversification?

What is diversification?

Diversification can involve including a greater number of asset classes, such as stocks, ETFs, indices, currencies, commodities and cryptoassets, in your portfolio. Spreading your capital across investments in different geographical regions or economic sectors is another form of diversification.

Allocating capital between stocks and bonds on a 70/30, 60/40 or 50/50 basis will be a good fit for many investors, but introducing more asset classes helps to mitigate risk and can have a range of other benefits.

Tip: Introducing higher risk assets doesn’t necessarily need to increase the total amount of risk across a portfolio. For example, investing 2% of your capital in cryptoassets will help you to gain exposure to an asset with much higher risk-return , without being over-exposed.

What is Diversification

Another advantage of diversification is that some of the assets in your investment portfolio can be expected to have low price correlation. When one is performing well, another may be showing a loss. The averaged out total return can make it easier to stick to your long-term strategy and reduces the risk of you selling an underperforming position too early.

For example, imagine a portfolio made up of just one instrument: Apple Inc stock. While that stock has posted significant returns for some long-term investors, its increase in value hasn’t been in a straight line. In 2022, AAPL stock fell in value by more than 25%. 

Apple Inc (AAPL) stock

Past performance is not an indication of future results

In the same year, the stock of healthcare giant Johnson & Johnson increased in value by approximately 5%. If the hypothetical portfolio had been split 50/50 between AAPL and JNJ, its lower volatility and averaged out annual loss would have been less difficult for a new investor to deal with, reducing the chance of them making emotional investment decisions. This is how a diversified portfolio helps investors manage risk and maintain a considered approach to investing. 

healthcare giant Johnson & Johnson (JNJ)

Past performance is not an indication of future results

The above example illustrates how diversification can smooth out performance, even between two relatively similar assets. This effect should also apply to a portfolio created with a wider range of asset types, but to a greater extent. 

Some assets that naturally appear to be uncorrelated may, in fact, have a strong correlation. It is important to avoid making assumptions and instead, research the historical price performance of the instruments you buy.

Tip: Copy trading  allows you to look at which assets experienced traders have bought, and how their portfolios have benefitted from diversification.

Managing your portfolio

Over time, your portfolio will be impacted by unexpected events relating directly to the wider market and the assets you hold.

You might find that the volatility of the instruments you hold changes over time, which could alter the risk profile of your portfolio. For example, Amazon Inc. has developed its business model to expand into web hosting services (AWS). While this doesn’t necessarily make AMZN a bad stock in which to invest, this change would influence the risk score of that particular position in your portfolio. Rebalancing your portfolio, which involves reallocating assets, is a crucial part of ongoing portfolio management, although investors should avoid the temptation to “overtrade.”

A diversified portfolio helps investors manage risk and maintain a considered approach to investing.

How to Build a Diversified Investment Portfolio

Final Thoughts

The way you structure your portfolio is a highly important part of the investment process. Being aware that some events are outside of your control is part of portfolio management, but it’s still worthwhile giving serious thought to the factors that you can influence.

Visit the eToro Academy to learn more about how to create the best portfolio for you.

Quiz

What is true for traders or investors with a conservative risk tolerance?
Their risk tolerance is likely to be low and their time horizon short
They are likely to hold more lower-risk investments such as bonds and cash, with less exposure to stocks
They are likely to have a broadly diversified portfolio
All of the above
 

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.

This information is for educational purposes only and should not be taken as investment advice, personal recommendation, or an offer of, or solicitation to, buy or sell any financial instruments. This material has been prepared without regard to any particular investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past performance of a financial instrument, index or a packaged investment product are not, and should not be taken as a reliable indicator of future results. eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this guide. Make sure you understand the risks involved in trading before committing any capital. Never risk more than you are prepared to lose.