Those who have kept money in a savings account (in one bank, currency, or asset) can certainly give plenty of reasons why one should neglect this option. Savvy market participants are aware that it is impossible sometimes to hedge yourself from headwinds in markets, especially a decline in the global market. Yet, investors can always diversify their portfolios to reduce risks.

Why should investors diversify their portfolios?

Warren Buffett has once said that "diversification is protection against ignorance”.

Nobody knows what the future holds. It is completely unpredictable. There are many examples that prove this statement, e.g. bankruptcies of such market giants as General Motors, Polaroid, and Metro-Goldwyn-Mayer. Sometimes, even states cannot avoid such fate. As investors are unaware of the future, they should always think about possible risks and ways to minimize them. When traders diversify their portfolios, they mix a wide variety of investments within a portfolio and limit exposure to any single asset or risk. Investment portfolios composed of several types of assets (stocks, bonds, currencies, etc.) ensure higher returns with less risk. It also helps weather the storm.

Make the revision of your investment portfolio considering the following factors to understand how well you have protected your investments from risks.

5 tips for diversifying your investment portfolio

1. Add to your portfolio various assets.

A diversified investment portfolio cannot consist of only one type of assets. It should include stocks, bonds, indices, exchange-traded funds, and other assets (cryptocurrency, metals, commodity futures, etc.).

Diversification implies the presence of mixed assets in the portfolio. When one asset enters the bearish market, others have the potential to grow. The ratio of assets in the portfolio may be 40/20/20, 50/40/10, 60/20/20, and 80/15/5. It all depends on your goals. If you prefer short-term investments and bet on a bigger profit, your portfolio is likely to contain many highly volatile instruments.

Useful tips on portfolio diversification:

  • Invest in shares of 5-10 companies. If you prefer short-term investments and quick earnings as well as you are ready for risks, then the percentage of shares in your portfolio could be 50 or higher.

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  • Pay attention to bonds. They provide regular returns and are less volatile than stocks. It makes them a perfect safety cushion during sharp swings in stock markets. The more you value less risky investments, the higher the percentage of bonds in your portfolio.
  • Keep in mind that indices (stock, exchange, PMIs) already represent diversified investments. For example, the S&P 500 index comprises 500 common stocks issued by 500 large-cap companies. The DAX 30 index represents 30 of the largest and most liquid German companies.

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  • Add to your portfolio various currencies, metals, fuel, and cryptocurrencies. These instruments will greatly diversify your portfolio. Just remember that their share should not be high.

2. Buy shares from different sectors.

If you want to add shares to your portfolio, buy shares from various sectors. Do not invest only in the IT companies or in the shares of blue-chip companies. The more diverse your shares, the better your risk management. For example, the shares of logistics and transport companies fell considerably during the pandemic, while streaming platforms and medical corporations gained in value. In this situation, if an investor had stocks from different sectors, this would significantly reduce his/her losses.

3. Divide your investments by economic indicators

Assets in the investment portfolio should differ by their profitability, capitalization, and volatility. Bear in mind that large firms may be affected by political factors but they have a greater potential for recovering quickly in times of a crisis. Apart from that, market giants deal with a wider market. This is why their losses may be far bigger due to quarantine restrictions in comparison with small companies. The latter may even increase their turnover. Analyze and weigh the risks to balance your portfolio as much as possible.

4. Broaden your geographical boundaries.

Do not choose only assets of one country for your investment portfolio. States may experience a crisis in different ways. One country may be facing a recession or a slowdown in economic growth, while the other may maintain and even increase the pace of expansion. Investors also may easily avoid losses due to some political or economic turbulence or a political crisis in a particular state by adding to their portfolio trading instruments from various countries.

5. Make a revision of your investment portfolio

Contrary to popular belief, diversification is not a one-time task. A concentrated stock portfolio may also expose investors to significant risks, especially when it was diversified a long time ago. For example, if one stock or a group of stocks in the portfolio brings a large profit. Another reason why the investment portfolio may become unbalanced is a change in the corporate strategy of the company whose shares investors hold (e.g. IBM's transition from selling equipment to providing technical services). To prevent the portfolio from becoming concentrated, track your results at least twice a year.

Conclusion

There are hardly any traders who like to incur losses. Therefore, it is better to diversify the portfolio to avoid them. Investing is a scrupulous and time-consuming process. This is not a one-time action. Evaluate your own trading instruments and try to balance the risks and profitability of your portfolio by following our advice. Keep an eye not only on changes in market conditions but also on the terms of commissions of brokerage companies. Do not forget about the importance of a portfolio revision. For instance, InstaForex clients have access to a great virtue of trading instruments. They know how to diversify their portfolios in order to get the best of it.