What Are the Benefits of Diversification?

Have you ever heard the saying "Don’t put all your eggs in one basket?". This is particularly relevant when it comes to investing. There are many different principles you need to understand when making an investment, but one of the most important is to ensure that your portfolio is diversified. What this basically means is that you’re not choosing one particular type of investment, for example buying gold or playing the stock market. Instead, you choose a number of different types of investment and thereby minimize the risk of losing your capital. Here are some of the reasons why diversification is such a good idea.

  • It minimizes risk – while one of your investments may perform badly, the others may perform better. You are therefore reducing any potential losses.
  • Your capital will be preserved – this is particularly important for older investors who want to preserve their capital and protect their savings.
  • Generates better returns – you are more likely to enjoy higher returns if your portfolio is varied as so many perform better than others and you aren’t relying on just one source.

How to Diversify Your Portfolio

Diversifying essentially means you have to spread your capital across a range of different asset classes. The mix should include growth assets in the form of shares or property. These will provide capital gains over a longer period of time, but the risk will be higher. The other class of assets will be defensive assets such as cash or fixed interest investments. The return on these will be lower. However, there will be an equally lower risk involved.

Other Assets You Can Include in a Diversified Portfolio

There are a number of other assets you can include if you want to diversify even further. For example, listed investment companies (LIC) and exchange-traded funds (ETF). LICs provide a way of spreading investments across a range of different assets and are very similar to managed funds. ETFs are open-ended investments, and you’ll need to find the Best ETF brokers to help with your investment decisions. They have become very popular with investors because they are an inexpensive way to diversify.   

Are There Any Downsides to Diversification?

There are really only two downsides, and neither are really significant. However, they are worth mentioning. The first is that a diversified portfolio will never be the biggest performer. It’s likely to fall somewhere around the middle of any performance ranking asset class chart. The other is that investors may find themselves feeling restless when looking at how other asset classes are performing. What has to be remembered is that a diversified portfolio is far less likely to crash, leaving you with nothing. The S&P500 is a prime example of how bad things can get. During the 2008/2009 housing bubble crash, it lost 55% of its value. While during the tech bubble collapse in 2000/2002 it lost 43%.

You should now be able to appreciate the value of diversification. When you’re making your investment decisions look at the bigger picture and make your choices wisely.