5 Steps to a Well Diversified Portfolio

“Don’t put all your eggs in one basket”. The simplest analogy and central thesis for why you should diversify your share portfolio, rewritten countless times in articles on the topic.

You already know that investing is the key to building long term wealth. Establishing an investing strategy is important to help get you there; however, having all of your eggs (money) in one proverbial basket (security) can mean that potential losses are amplified.

A well diversified investment portfolio will temper these potential losses and should be considered when building a share portfolio.

Before you go run for an ETF, I have some tips to inject a bit of diversity into your portfolio.

Diversification can extend beyond your share portfolio

As a business journalist you’d assume I’m exclusively talking about shares when I tell you to diversify. Quite the contrary actually!

You don’t need to diversify your asset portfolio over one asset class. An asset is anything that has value and (hopefully) appreciates over time.

Historically the three main asset classes are:

  • Equities- stocks
  • Fixed income- bonds
  • Cash equivalents- think hard cash, liquid funds or your savings account

Whilst there is nothing wrong with diversifying over these three, consider thinking outside the box. Real estate is an obvious alternative, and the world’s largest asset class, but have you ever thought of collectibles, foreign currency, or private equity?

ETFs are great, but…

ETFs are a brilliant way for investors to get exposure to assets they would have otherwise been unable to access. The pooling of capital from multiple people means asset managers can purchase stakes across a broad range of industries and asset classes. Lauded for checking the diversity box, ETFs can broaden the scope of the portfolios of small and large investors alike. ETFs also cut down on time and effort required to manage and allocate investments.

That being said, it’s important to understand the ETF you are entering. Some ETFs have fees associated with them. Investors need to view the ETF’s expense ratio to determine how much the running costs of the ETF are.

Additionally, investors must remember that ETFs are just as prone to volatility as the rest of the market. Whilst often well diversified, it’s a good idea to check the industry spread of investments in the ETF to ensure that the downfall of one industry won’t massively impact you.

When investing in an ETF you may find your money going towards an industry or company that you are morally or otherwise opposed to. Having someone else pick the investments for an ETF is appealing for some but a limitation for others who may choose to omit ETFs from their portfolios due to issues of control.

Diversify by location and industry

Using the COVID-19 pandemic as the most convenient analogy- lockdowns in Melbourne have impacted businesses located in Melbourne. As a shareholder with investments only in Melbourne based restaurants, you’d be reeling at the loss.

To temper the fluctuations of different economies experienced by businesses, investors need to diversify based on geographic location as well as industry.

Certain industries fare better at certain times of year or adapt better to change. Take for example, the beauty industry which came to a screeching halt as a result of lockdowns due to the high touch, face to face nature of it. Retail on the other hand, has thrived due to increased online shopping which can be done remotely.

Consider investing across multiple markets, regions and industries to build a truly robust portfolio that will be able to withstand uncertainty or loss in one area, without amplified losses.

Avoid spreading wealth too thin

There is such a thing as a portfolio that is too diverse! Holding 50 investments that you don’t have time to manage or adequately track can lead to losses due to oversights or a missed announcement. As much as we wish there was, there is no ‘magic number’ of assets to hold. Ultimately, investing has to suit you. If you’ve got time on your hands and enjoy following daily market activity then you may identify as more of a trader whereas if you’re like me, and prefer to set and forget, you’re more of an investor.
Regardless of where you are on the trading/investor scale, diversification is crucial, just not too much.

Consider investing in varying risk levels

Each investor will have their own risk tolerance, and it’s important to ask yourself questions to determine these. That being said, a riskier investor should try to mix in some steadier stocks or assets to support the growth stocks and balance out losses. Similarly, a conservative investor might want to look at adding some more high risk growth stocks to their portfolio.

Investing across risk levels means that the shareholder is exposed to differing rates of return to either prop up or add to portfolios.

If you want to get the ball rolling on creating your diverse investor portfolio and are not sure where to start, click here to enrol in a free beginners online course for stock market trading and investing.