The Importance of Investment Portfolio Diversification
One proven way to spread risk comfortably throughout your portfolio, is to make sure you sufficiently diversify your investments.
Investment portfolio diversification is a tried and tested technique that involves reducing risk by spreading investments across a varying range of companies, sectors, geographical locations and assets. Obviously, diversifying your investments is not an absolute buffer against financial losses. However, it remains a vital strategy for minimising risk that often helps investors to achieve their financial goals.
Why does investment portfolio improve your chances of growth and success? An investment portfolio containing investments with little or no relation to each other, also known as low correlation, is in less danger of being heavily impacted upon by negative value fluctuations in any one company, sector, country or asset. Diversifying your investment portfolio often enables falls in the value of one investment to be cushioned by rises in the value of another unrelated investment.
Here are the key ways you can diversify your investment portfolio:
Diversify Your Company Investments
It’s obviously common sense not to invest all your money into a single company. Little is certain in the current economic climate and even the most prosperous of companies can suffer a fall in value or even fold. Always spread your investments across a number of companies and consider investing in companies that operate in different market sectors. It’s vital to conduct thorough research into any company you are interested in investing in and to seek the advice of an independent financial advisor prior to making a final decision.
Diversify Your Sector Investments
Investing in a range of different sectors brings the same advantages as investing in different companies. In the current economic climate there have been peaks and troughs in a wide range of sectors. To provide a cushion with your investment portfolio against your entire portfolio losing value, spread your investments across sectors with low correlation. For example, if your investment in a company within the education sector suddenly experiences a dip in value, a rise in your gold investment could compensate for it.
Diversify the Geographical Locations of Your Investments
A good way to minimise the effect of stock market movements is to spread your investments across different countries and separate regions. It’s quite a risk to place all your faith in the economic stability of a single country and the financial policies of its ruling government. Again, it’s crucial to conduct research into the stock markets of different countries and get expert advice from an independent financial advisor before making any investment decision. Calculate the risk involved before choosing to invest abroad, as some less developed markets are more volatile than others and can be affected by systemic risks. Get as much information together as you can while planning and building your investment portfolio with your financial advisor.
Diversify Your Assets
It’s wise to have a good mix of varying asset types within your investment portfolio, as it spreads risk. There are many different types of assets, the primary types being shares and bonds, which often have a low correlation to each other. Discuss with your independent financial advisor the best way to mix the asset types within your investment portfolio. They will have the market knowledge required to spread the risk throughout your portfolio. You should decide the level of risk you are willing to take according to your financial goals. Are you near the time you want to draw upon your invested money? Then go for lesser risks. If you are planning a long term investment strategy, you may feel inclined to take greater risks. Remember to work with your financial advisor to create a portfolio tailored to your personal financial goals.
Avoid Over Diversification
While diversification can protect your investment portfolio from value fluctuations in correlated investments, over diversification can lead to you not having enough invested money in a company or sector to truly benefit from any growth. Again, it’s a case of planning your investment portfolio carefully with your financial advisor and striking the right balance.
