Portfolio diversification benefits
Now you will find out about one of the most popular investment strategies – diversification. Diversification helps you to properly allocate investments and not focus on any one type of assets, thus the volatility of your portfolio gradually decreases. It is one of the methods of risk management.
Investment diversification is one of the ways to maintain a balance between risk and reward in your investment portfolio. And for this, you just need to spread the portfolio across several asset classes. The advantage of shareholder diversification is the ability to reduce the risk and volatility of the portfolio. But remember, there is no guarantee.
Also, diversification refers to banking services along with checking and savings accounts, loan and mortgage services, financing for automobiles, and short-term loans like overdraft protection.
Let’s talk about Individual Savings Account or ISA. As you may know, ISA gives you the opportunity to invest in individual shares, funds, trusts, property, corporate bonds, government bonds, and much more.
If you are a stocks and shares ISA investor, then you are most likely searching not only for making a profit without paying taxes but also for wider diversification of investments in order to secure them.
Since ISA provides an opportunity to invest in a large number of assets, there is a risk of over-diversification. This will happen if you spread assets over too many areas. Take your time – find a balance! Also, look at multi-asset funds as this could potentially balance the risk when looking for higher returns.
You are able to use our ISA Calculator (https://orca.app/uk/invest/isa-calculator/) to assess your opportunities in financial diversification of your personal finances. ‘Personal finance’ refers to managing personal money as well as saving and investing. But the term also includes budgeting, banking, insurance, mortgages, investments, retirement planning, and tax and estate planning. It can also apply to the entire financial industry, which deals with individuals and households.
Also, get acquainted with the General Investment Account (https://orca.app/uk/invest/gia/ yeah, we call it GIA).
So, portfolio diversification benefits are reducing risk, hedging against market volatility, and higher returns in the long run.
The basics of diversification
Is diversification your investment strategy now? We hope so.
With diversification, if some investments show poor results, then investments with good results neutralise them. Note that the benefits of diversification in financial management last only if the securities in the portfolio react differently to market influences.
It has been proven that if your portfolio contains 25-30 shares, and it is diversified, then maintaining it will provide the most cost-effective level of risk reduction. When investing in securities in large volumes, diversification provides additional benefits, but at a significantly smaller rate.
Usually, there are 4 main components of a diversified portfolio and 4 additional ones (there you should say: ‘Bring them on!’). Ok, ok, here they are:
- Domestic stocks
This is the most aggressive part of your portfolio, which contains the potential for higher growth, which in turn carries more risk, especially in the short term. And remember the fact that stocks are more volatile than other types of assets. This means that when sold, the stocks may be worth less.
Regular interest income and less volatility are what investors love bonds for. Also, their great advantage is the ability to act as a buffer against stock market fluctuations. Some investments, such as high-yield bonds and a small number of international bonds, offer higher returns, but the risk will be higher.
- Short-term investments
These are short-term certificates of deposit (CDs) and money market funds. Let’s talk a little more about these funds. They are conservative investments that offer stability and easy access to your savings. If you want to keep the principal, this is your option. If you choose safety then incomes go the other way – the yield will be lower than that of bond funds or just bonds. Money market funds are considered safe and conservative, but there is still no guarantee.
- International stocks
If you want to potentially get a lot of income and at the same time you are not afraid of risk, then pay attention to foreign stocks. Different markets often work in different ways, so you are able to take advantage of opportunities that your country’s securities don’t offer.
- Sector funds
These funds are focused on one segment of the economy. Take a closer look at them, if you are looking for opportunities in different phases of the economic cycle.
- Commodity-focused funds
If you want to get a good hedge against inflation protection, then this is exactly what you need. To do this, add commodity-intensive stocks (for example, oil, gas) to your portfolio.
- Real estate funds and real estate investment trusts
They are able not only to diversify your portfolio but also to provide some protection against the risk of inflation.
- Asset allocation funds
If you are new in the investment or don’t have time to diversify the portfolio, then asset allocation funds are able to help you with this. Try our beginner stock trading app (https://orca.app) and make your first steps in investment.
So, what does diversification mean for investors?
- If you combine different investments in a portfolio, then your strategy is diversification.
- Diversification of portfolio meaning you focus on not one but several types of assets.
- You are able to diversify your portfolio:
- by asset class;
- inside classes;
- invest in domestic and foreign markets.
- One of the benefits of diversification is to limit portfolio risk, but performance might be affected.
- The strategy used by investors to manage risk is diversification risk definition.
Examples of financial diversification
Often, to explain the definition of portfolio diversification, a proverb is cited as an example: “Don’t put all your eggs in one basket”. In other words, don’t invest all your money in one asset. It’s no secret that an individual stock can drop 50% in a year. The probability of this outcome for a portfolio of 20 stocks is much less, especially if they are randomly selected. Therefore, choose stocks from different industries, companies of different sizes, and types of assets.
Imagine an investor who sticks to a diversification strategy. He is willing to take on a high level of risk, which is why he has Chinese stocks, US bonds, and precious metals futures in his portfolio. Thus, the investor really owns a diversified portfolio of investments.
One more example. You are American and a big fan of Taylor Swift: you have only her songs on the playlist and you play it over and over again, but one day everything is gone (it is just an example, relax) and you have nothing. But what if you were a big fan of Adele, Little Big, BLACKPINK, Zara Larsson, and Måneskin too? Do you have an answer? But what if we say, they are from the UK, Russia, South Korea, Sweden, and Italy? You would lose all of Taylor Swift’s songs (of course it is sad), but still, have a lot of different music from different artists. This is what diversification is about.
I knew you were a troubled investment portfolio, so I have diversified it. Look what you made me do.