How to Diversify Your Portfolio

As the Little Red Riding Hood was preparing to make her trip, she contemplated the task at hand. Although there was one way to her grandma’s house, the forest was big — so making more than one trip was inconvenient. Also, she couldn’t carry a lot and insurance premiums for disobedient children were too high. So, she accepted the risk and put all the eggs in one basket.

Fortunately, when investing in the financial markets you have plenty of options. Read on to learn how to diversify your portfolio — how to reduce the risks, volatility or even increase the profits.

What is Portfolio Diversification?

Portfolio diversification is a key investment strategy. It means spreading investments across different asset classes, like stocks, bonds, real estate, and commodities. This approach limits exposure to any one asset, which reduces risk. When one asset class performs poorly, others may do well. This helps protect the overall value of the portfolio. Diversification can lead to more stable returns over time. It might result in lower returns compared to focusing on high-performing stocks. However, it is a smart way to manage market changes and guard against significant losses. While it may lack the excitement of high-performing stocks, it lowers risks and enhances investment stability.

Why Should You Diversify Your Investment Portfolio?

Diversifying your investment portfolio is key. It reduces risk and improves potential returns. By spreading investments across stocks, bonds, real estate, and commodities, you lower the impact of any poor-performing investment. This approach protects against market volatility and adapts to different market conditions. Diversification is essential for both new and experienced investors, especially in uncertain economic times. A varied portfolio leads to more stable long-term growth and boosts your investment potential.

Risk Reduction

Diversifying your investments means spreading your capital across different assets. These can include stocks, bonds, real estate, and commodities. This strategy helps to minimize the impact of poor performance in any one investment. Losses in one area can be balanced by gains in another. For example, if one stock declines, other investments might remain stable or increase in value. This provides a buffer against significant losses. Overall, this approach lowers the risk of your portfolio. It makes your investments less vulnerable to market volatility and economic downturns.

Increased Potential for Returns

A diversified portfolio can increase your chances of achieving returns by benefiting from performance across different markets or asset classes. Various investments behave differently based on economic conditions; for instance, technology stocks might rise during periods of economic growth, while utility stocks typically offer consistent returns during downturns. By maintaining a variety of asset types, you can capitalize on growth opportunities across sectors, which can enhance your overall returns and contribute to a more robust investment strategy.

Smoother Performance

Diversification helps create a more stable investment experience. It balances volatility across your portfolio. By investing in different asset classes, you can reduce the effects of market fluctuations. For example, if equity markets are unstable, bonds or safer investments may retain their value or increase. This can lead to more consistent overall performance. Such stability allows you to remain invested during challenging times. It also helps you adhere to your long-term investment strategy and avoid impulsive decisions based on short-term market changes.

Diversify Your Investment Portfolio

Diversifying your investment portfolio helps manage risk and improve potential returns. By spreading investments across different asset classes like stocks, bonds, real estate, and commodities, you can protect against market volatility. This strategy can also take advantage of opportunities in various sectors. It reduces losses and improves the chances of steady growth over time. Investors often need to balance the desire for high returns with the need for security. Diversification becomes a key tool for a balanced investment strategy. In this guide, we will explore methods and tips for building a strong portfolio that fits your financial goals and risk appetite.

Use Different Asset Classes

The baseline asset classes are stocks, bonds and cash. While investment professionals are able to generate returns with concentrated investing, a balance among these asset classes is the best approach for retail investors.

Although there is no clear consensus on this balance, there are 3 factors it will depend on:

• Investment goal: What is the reason for investing?
• Time horizon: How long are you planning to invest?
• Market cycle: Where are we in the market cycle?

While the first two questions are personal, the last one is harder to answer. Read more on advanced investing techniques to familiarize yourself with the market cycles.

Balance Your Portfolio by Sectors

Even if you’re heavily invested in stocks (for example, early in the market cycle), you should still spread your investments over different sectors. The market is divided into 11 sectors: energy, materials, industrials, consumer discretionary, consumer staples, healthcare, financials, information technology (IT), telecommunications, utilities and real estate.

Each of these sectors has a history of outperformance in certain scenarios. For example, financials do well in the high-interest rate environment, utilities and consumer staples do well in downturns, while consumer discretionary and IT do well in the bull markets.

A good portfolio will have a balance between these to reduce the market volatility. While you can go slightly overweight or underweight in certain scenarios  — that has to be done research-based and in moderation.

Invest in Foreign Markets

While researching the foreign markets was somewhat slow and sometimes inaccurate, in 2023 this is no longer the case. Staying on top of the foreign market news can be as easy as on the domestic ones.

For those who invest time in researching global affairs, geo-diversification can be a great tool to mitigate risks. Besides, foreign markets with different economic cycles can reduce the volatility of returns. For example, thanks to its exports Australia avoided recessions for almost 30 years (even the Great Recession of 2008).

Although research shows that long-only geographic diversification outperforms industry diversification, be aware of risks when investing abroad: political risk, currency risk and credit risk.

Include Commodities and Real Estate

Commodities are the oldest way of storing wealth. They are also a great way to mitigate inflationary risks. While the market is debating inflation in 2023, investing legends like Dr. Michael Burry and Warren Buffett have been raising concerns about the price of commodities and hidden inflation.

Yet, storing commodities, like operating real estate, can be an expensive venture. So, diversifying in these asset classes can be done through commodity exchange-traded funds (ETFs), real estate investment trusts (REITs) or innovative platforms like Groundfloor or Fundrise. Read more on the importance of diversifying your real estate portfolio.

Research Alternative Opportunities

No other asset class allows you to be as creative as alternative investments. While this can be anything from baseball cards, music royalties, peer-to-peer lending, try to resist the temptation and invest in what you understand. If you like working on cars consider getting a collectible, if you used to play games like Pokémon or Magic: The Gathering — go through your old collection, as some of those cards are now worth 6 figures.

In 2023, it is easier than ever to invest in online businesses. The possibilities are endless but they need to be reasonable.

Commissions and Fees: Key Considerations for Every Investor

When investing you have to keep your eye on various commissions and fees. This will depend on your investing style, goal and time horizon. If you’re more of a trader than an investor you should consider using a zero-commission broker. These brokers got more popular in the last few years. But, if you are a low-turnover investor who just does periodical portfolio rebalancing, you might pick a full-service broker and enjoy the benefits like extra research.

Timing Your Diversification Strategy

While timing the market is a fool’s errand, timing your diversification strategy should be straightforward. After all — you should know the goal of your investing and plan its timeline.

Saving in the short term compared to the long term is often counterintuitive. You might think to take high risk for the short term and low risk for the long term but it is the other way around.

In the short term, you don’t have enough time to endure systematic (nondiversifiable risk), so for the short-term goals, your investing needs to be low risk. 

Meanwhile, your long-term investing has enough time to recover for potential drawdowns. This is why a retirement portfolio can be heavily allocated in assets like equities. 

The goal is to take advantage of the growth and compounding while enduring the downturns. Eventually, this portfolio will become large enough that even low-risk assets will generate significant returns for a sustainable lifestyle. If you are a beginner investor, read more on how to protect your portfolio in 2023.

Mistakes to Avoid When Diversifying 

Portfolio diversification is important for reducing risk and improving potential returns. However, many investors make mistakes that weaken their diversification. It is crucial to understand these common errors to build a strong portfolio. This guide will highlight key mistakes to avoid in portfolio diversification. By doing so, you can enhance your asset allocation and minimize risks. This will help your portfolio grow more sustainably over time.

Not Diversifying Enough

The only thing worse than not being diversified is not being diversified while you think you are. Buying a few stock indexes might get you invested in hundreds of companies — but in markets with non obvious positive correlation. You should pay close attention to how the parts of your portfolio react to market fluctuations. If they all move in one direction, you might have a problem.

Over-Diversifying

The benefits of diversifying (especially in an asset class like stocks) peak pretty quickly. If you keep adding more securities with a similar risk profile, your performance will mimic that of the broad market. Overdiversification equals “diworsefication” — a term coined by a legendary mutual fund manager, Peter Lynch.

Not Rebalancing Your Investments

Change is the only constant in the world — so, rebalancing your portfolio at some point will be inevitable. This will entail some tough decisions, but remember that money goes in your pocket only when you take the profits. A rule of thumb is to check on your portfolio at least quarterly, rebalance it at least once per year and be mindful of the market cycles.

Missing Out on Alternatives

Alternative investments can be a great way to diversify. This is the creative corner of investing as anything from vehicles through Lego sets to online businesses can be a good alternative. This can be an outlet for you to leverage your personal expertise, hobbies and connections.

Track Your Portfolio With Delta

The Delta Investment Tracker is a mobile app that helps you track all your investments in one place. The app is rated quite well and supports over 7,000 cryptocurrency tokens from Bitcoin to Litecoin, Ethereum and a range of altcoins. You will see charts that offer information on all your tokens, and you can set your charts to your local currency to avoid confusion.

You can connect to more than 300 exchanges so that you can also make moves when you see the profit/loss statements in the app for every token you’re holding. You can also divide your tokens in a number of other portfolios so that you can group them properly and track them by owner, strategy or exchange. 

Want to take your tracking further? You can add your stocks, ETFs and other assets to this tracker so that you can see every dollar that has your name on it. This is a great way to track how your money is performing, see the “big picture” and plan for the future.

Sync up to 5 devices when you sign up for Pro, and remember that you can use those synced accounts on all your mobile devices or share this information with your money management clients. 

Best Brokers to Diversify Your Portfolio

The most convenient way to diversify is to control your positions on the market through brokers — regulated intermediaries that buy or sell the securities for you.

You can see the comparison of our recommended brokers in the table below.

Diversify in Moderation

While fairy tales have happy endings, financial markets operate in reality. Its forests are deep, dark and full of predators — but also, filled with game, fruit and other riches. It is up to you to pick one of many paths that lead to your goal and stick to it.

Bringing the diversification along will have a price, yet it can be a small price to pay for peace of mind. But remember — don’t pick up more baskets than you can carry.

Frequently Asked Questions