Investing, whether we're talking stocks, funds, commodities or real estate, can seem intimidating to many beginners. Imagine if the investment drops to zero and all your money goes straight down the drain?
But it doesn't actually have to be so incredibly scary.
One of the most important strategies that many experts highlight is diversification. In this article, we take a closer look at how you can spread your money, and how much diversification is enough to limit the downside without affecting the upside.
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What is diversification?
Diversification is about spreading your investments across different asset classes, companies, industries and markets. The purpose of this is to distribute risk and potential returns in several areas. Examples of what can be included in a diversified portfolio:
- Stocks from different industries and sectors
- Bonds
- Real Estate or REITS
- Commodities
Diversification gives you the opportunity to expand your portfolio beyond one sector or one country. The value will always have ups and downs over time, but by spreading your risk you reduce the chance of stinging losses when certain industries do worse than others.
How can I effectively diversify my portfolio?
Diversifying your portfolio is for the vast majority of people – and especially beginners – an important part of a successful investment strategy.
1. Different sectors and industries
To effectively diversify your portfolio, you should first consider investing in stocks from different industries and sectors.
This will reduce the risk that changes in an industry or sector will affect your entire portfolio.
2. Different assets
Another way to diversify is to invest in different types of securities, such as shares, gold/silver, bonds or property. This will also reduce your risk and give you the opportunity to get returns from different sources.
3. Invest across borders
It is also important to consider geographic diversification. Investing in stocks from different countries and regions can help you avoid risks associated with political and economic conditions in a particular country or region.
4. Companies of different sizes
Another way to diversify is to divide your portfolio between large and small companies. Large companies can provide stability and long-term growth, while the smaller companies can provide explosive returns over time, given that the growth is good.
Get started with investing at Nordnet
I recommend Nordnet because of their large selection of shares and funds, low fees, good learning resources + free access to the share forum Shareville (ad).
How to diversify your portfolio
There are many ways to weight different assets in your portfolio. I recommend that you check out PortfolioCharts.com for an overview of diversification models that may suit you.
Examples of how you can diversify your portfolio:
To diversify your portfolio, you must first determine your risk tolerance. If you are young, you can advantageously dare to take a little more risk than if you are approaching retirement age and do not have the time and money to withstand larger losses.
Read also: shares for beginners: a great guide to investing in shares and fund
How much diversification is enough?
Diversification is an important strategy for minimizing risk and achieving long-term financial success. By spreading your investments across different markets, companies, industries and asset classes, you can reduce your exposure to potential losses in a particular sector or stock.
But that does not mean that you should have an excessively diversified portfolio.
Charlie Munger and Warren Buffett, two of the world's most successful investors, share a common philosophy when it comes to diversification.
They both believe that diversification is nonsense, for those who know what they are doing.
This is in sharp contrast to what other investors (such as Ray Dalio) thinks, but it makes sense, from the perspective that it is easier for you as an investor to keep track of a handful of companies than hundreds.
And that's why I initially point out that diversification is wise for beginners who don't have the time or interest to keep a close eye on their investments.
Excessive diversification is not recommended - especially if you have little funds, scraping your money too thin on your bread slice will make it more difficult to make your money grow quickly.
But it is also important to do thorough research and make informed decisions when investing. It is not enough to simply spread your money over several investments and hope for the best. Therefore you should read my articles about investment on this blog, and then learn as much as possible.
Know what you are investing in
Having a concentrated stock portfolio requires both extensive stock analysis and that you pay close attention. After all, you need to know as much as possible about your investments - and especially if you only have a few of them.
Therefore, you need to know the company's fundamental condition, such as debt ratio, income, cash flow and more.
You must therefore take responsibility for your investments and make thorough analyzes before making decisions.
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