Managing risk and maximizing profits are two of the most crucial fundamentals of investing. Diversification allows investors to minimize and manage risks and protect their investments. When diversifying, they must include investment options with different risks and returns in their portfolio. Here’s what you need to know about this strategy and how to leverage it in your investment journey.
Find Investments with Little Correlation
Many investors make the mistake of investing in closely related stocks. For example, one might invest in tech or banking stocks because those industries are doing well at that time. However, this means that the prices and values of these investments will go up or down together, so a collapse in a sector one has heavily invested in has the possibility of wiping out their investment.
If the prices and values of the investment options in your portfolio move together like this, you have not diversified enough. You have to exit some of your positions and find new investments that will provide relief if one type collapses or loses value.
You can still invest in exchange-traded and mutual funds if you want to invest in a single sector. However, that will count as one investment and not multiples, as it would otherwise.
Diversify Globally
Because there are so many investment opportunities in the United States, many new investors forget that there are additional opportunities all over the world. Instead of only focusing on one location, look outside the United States for opportunities, particularly in Europe, Asia, and emerging markets.
Doing this is also a great way to protect yourself and your investments from news or events that only affect the United States or the country you are focused on. Although there will be bumps when you invest in these alternative markets, doing proper research should surface opportunities for long-term growth that you can target.
Rebalance Your Portfolio
Since different investments perform differently over time, they will gain or lose value. As this happens, the investments performing well will have a higher weight than those not doing well. Rebalancing your portfolio will help you keep the appropriate weight for each investment while also helping you balance risk and reward.
Investors must keep an eye on things like major world events and market volatility that can trigger the need to rebalance their portfolios. Under normal circumstances, investors should do this every three to six months.
Consider Your Risk Tolerance
Risk tolerance is the degree of uncertainty or risk an investor can tolerate or accept. Your level of risk tolerance can impact your diversification efforts and impact where and how you invest. For example, you might want to invest in new stocks to diversify or rebalance your portfolio.
You might look at a list of the currently most shorted stocks to see whether investors think their price will fall or rise. If you find a stock on the list, you might take the risk and short it, or decide the risk is too high due to the possibility of little to no recovery.
Think Beyond Bonds and Stocks
Many investors only think about stocks and blinds when diversifying. However, there are numerous other options available to them. For example, index funds are a great option and have been performing relatively well for the past two decades.
Investment opportunities like real estate investment trusts (REITs) and commodities are excellent alternative diversification options. With REITs, another party manages them, so you do not have to think about it. Commodities, on the other hand, perform well, but you need to know what is happening in the world and look ahead before investing in them.
If you are not diversifying your portfolio, you are putting it at risk and not making the most out of your investments. Fortunately, there are numerous ways to diversify a portfolio and minimize risk as much as possible. Remember to review your portfolio regularly to see what changes you need to make and to take advantage of emerging opportunities.
