In the realm of investing, the saying "Don't put all your eggs in one basket" encapsulates the essence of diversification.
But did you know there’s a specific, secret rule you can follow to do this? Read till the end to find out what it is!
But first, let’s get a better understanding of what it means to diversify your investments.
What Does Diversification Mean In Investments?
Diversification is a risk management technique where investments are allocated across various financial instruments, industries, and other categories.
The goal is to protect the portfolio against significant losses. Because asset classes often behave differently under various market conditions, by diversifying, an underperforming investment can potentially be offset by other investments that are performing better.
Benefits of Diversification In Investments
Reduces Risk
This is the most apparent benefit. By investing in a variety of assets, the impact of a poor-performing investment is minimized.
For instance, if you were only invested in stocks and the stock market crashed, you might face severe losses. But, if you're also invested in bonds, real estate, or other assets, these may hold up or even thrive when stocks underperform.
Potentially Higher Returns
Diversifying can help you achieve more consistent returns over time.
While it might reduce the potential of "hitting it big" with a single investment, it provides a smoother, more predictable growth trajectory.
Access to a Variety of Assets
A diversified portfolio gives you exposure to different sectors, asset classes, and geographical regions. This broad exposure can be beneficial in times of local or sector-specific downturns.
Flexibility in Changing Markets
As markets evolve, having a diversified portfolio allows you to reallocate and adjust more fluidly, seizing new opportunities and mitigating emerging risks.
How To Diversify Your Investments?
Across Asset Classes
This involves mixing different types of investments like stocks, bonds, real estate, commodities, and even alternative investments like cryptocurrencies.
Within Asset Classes
It's not just about having different types of assets but also about diversifying within each type.
For instance, instead of investing in tech stocks alone, diversify across sectors like healthcare, utilities, and finance.
Geographical Diversification
Don't limit yourself to your home country.
Investing in international markets can provide added protection against domestic market slumps.
Personally, I also invest in US stocks as returns are usually higher and there are more established companies over there. Here’s an app I use to trade my US stocks. You can also find out more about M+ Global here.
Dollar-Cost Averaging
By investing fixed amounts at regular intervals, regardless of market conditions, investors can reduce the impact of market volatility.
The Five Percent Rule
Finally, the secret rule I've been talking about. The five percent rule is a concrete guideline to ensure diversification.
This rule suggests that no single investment or asset should constitute more than five percent of your entire portfolio.
For instance, if you’ve taken an interest in tech stocks, according to rule, you’ll only want to allocate five percent of your portfolio to those stocks. This is because while tech companies like Apple or Google are dominant players, the dot-com bubble burst serves as a reminder of the potential risks of over-investing in just one sector.
Conclusion
In the unpredictable world of investments, diversification remains a cornerstone of a sound investment strategy.
While it doesn't promise total protection against loss, it plays a vital role in managing risk and aiming for steady, long-term returns.
However, even with diversification, you should still periodically review and adjust your portfolio to ensure it aligns with your financial goals and the changing market dynamics.
Subscribe to our financial newsletter for the latest news, insights, and advice on personal finance, investing, and more. With every email, you’ll gather the confidence and knowledge to make informed decisions to achieve your financial goals.