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I’ve seen far too many horror stories in the world of investing to know the importance of diversification. Many new investors jump in for the first time by buying an asset, that they know the business and see that it is growing fast. They see the price increasing and get excited. So they decide to dump most of their capital on this one investment, expecting to make their fortune. Here’s why this is a huge investing error…

1. They might have missed something:

As a new investor, it is likely that you will make mistakes. Even if the stock or property or other asset looks amazing and you think for sure this will go up in value. Starting out, no matter how much research you do beforehand there’s some things you’ll never know to watch out for unless you have investing experience in the certain asset class. 

This means, no matter how prepared you are as a newbie, you will make mistakes in your asset choices. This is why diversification is key to spread the risk in case you accidentally make a bad decision on one investment.

2. If you are wrong, you will lose everything:

Putting all of your investment capital into one single asset is super risky. As mentioned above, you are likely to make mistakes early on. If you happen to make a mistake on this one investment, the value of the asset will decrease and you will lose a significant portion of your wealth.

3. Diversification broadens your winning chances:

If you choose to invest in just one asset, you’ll miss the chance to be in on another brilliant growth opportunity. Sometimes it’s the underdogs that do well. Choosing a variety of what you believe to be undervalued assets broadens your chances of finding a winner that has a great turnaround to give you amazing returns.

Successful Diversification

So now you know why it is important to diversify your investments, you now need to know how. What do you need to look out for and what constitutes a good diversification strategy?

1. Invest in more than one sector:

When looking to spread the risk in your investments, not only is it important to choose different assets, you should look to have assets in different sectors of business. For example, if you were choosing a stock market portfolio, you should look to spread your capital in different companies. In areas such as, pharmaceuticals, banking/ finance, construction, technology, engineering, travel and tourism etc. This way, if bad news comes out for the travel industry for example, you’ll lose some money in one or two stocks; But your others are likely to stand firm or still grow in value, covering your  unforeseen losses.

If possible, it could be a good idea to diversify through different asset classes too. This could mean separating your portfolio into stock market investments, property, bonds etc. This is useful for the reasons as mentioned before. Benjamin Graham, the author of the Intelligent Investor is a strong advocate of this style of diversification. 

I understand that sometimes diversification can be difficult. Particularly if you are a beginner, you are likely to be starting with low amounts of money. In this case, it would be difficult to stretch your capital into different assets. In this case, I love the idea of investing in index funds and investment trusts. This is a ready diversified portfolio which trades on the stock exchange. It means you only need to buy one asset and your money will be diversified in many different areas. 

2. Choose assets of varying risks:

If you are looking for strong growth within your portfolio, this often comes with a slightly higher amount of risk. In this case it often is a good idea to hold some slightly safer investments. This is to cover the risk of the more speculative positions. This could mean investing in bonds or perhaps a solid dividend paying stock. These types of investments wont likely give you a huge return each year but they will be more stable. In times of volatility, you’ll be thankful for the stability these assets offer should you need to liquidate at any time.

3. Not too much But not too little:

Although Diversification is a hugely important element to reducing risk in investing. It is possible to over diversify. Spreading your wealth too thinly will reduce the amount you can put into the assets you think are likely to grow faster. It is also harder to keep track of lots of investments at any one time and the workload of maintaining your portfolio could be overwhelming. 

Generally speaking, the more wealth you have, the more widely you will be able to diversify. But if you are not sitting on a lot of wealth it is still important. For example, if you were investing in the stock market, I often look to have between 7-10 stocks of varying sectors in my portfolio at any one time. This way, I can focus on choosing the investments I like the most but I still spread the risk, should one investment struggle.

Well that’s my take on diversification…

I hope you found value in this post and will look to maintain a more balanced and rounded portfolio in future. If you liked this post or have anything to ad, let us know in the comments section below. 

Would you like to learn more about my investing philosophy? You may find the Investing section of the Money Your Concern website useful.

Thanks for reading. Talk soon.

Harry