Diversification is one of the most preached investment gospel. In their aim to get outsized returns, some prefer to have a concentrated portfolio of just a few stocks. Others prefer holding 15 to 20 stocks to ensure there're diversified. There is no right or wrong.
The issue with having a concentrated portfolio is the huge downside if you’re wrong. This is why most people are better off having some form of diversification. But what exactly does diversification entail? Is spreading your capital across 20 stocks considered diversification?
When all your stocks are in the technology sector, are you really diversified? While it’s true that you are diversified across many stocks, this means little if they all belong in the same sector.
How To Diversify Your Portfolio Properly?
1) Sector Diversification
Spread your capital across different sectors. That way, if one sector were to crumble, you still have many others holding you up.
The S&P 500 provides a breakdown of the 11 sectors, each having its own ETF.
2) Geographical Diversification
It's common to have home country bias, where you only invest in securities listed on the stock exchange of your homeland. However, it's worth exploring companies in different countries.
3) Asset Class Diversification
It's not enough to just allocate capital across different geographical locations. Another thing to consider is investing across asset classes.
Examples of asset classes include:
4) Time Diversification
Time is the best friend of a long-term investor. Invest regularly and consistently. Spread out your investments across a long period of time.
Not only does dollar cost averaging lower the volatility of your portfolio, it also yields greater returns over time.
"Diversification is a protection against ignorance." Most of us think we know what we're doing when in reality we don't. We think we're diversified when really we're not.