Investment Diversification: How to Build a Diversified Portfolio
Investments 101
9.11.2024 1:03 AM
"Never put all your eggs in one basket." This is probably the first phrase that comes to mind when we hear the word "diversification." In reality, this expression perfectly reflects the central idea of diversification in the financial world: not relying on a single investment, but rather on multiple investments to reduce the risk in our portfolio. Thanks to this strategy, your portfolio can generate considerable returns without significant fluctuations over time.
Are you interested in learning more about diversification? In this Hapi article, we explain what diversification is and how to build a diversified portfolio if you are just starting in the world of trading.
In finance, diversification is the strategy of combining a wide variety of investments within a portfolio. A portfolio's positions can be diversified across asset classes, within a single asset class, and even geographically by investing in both domestic and foreign markets. Diversification limits the portfolio's risk and, in the long term, can help achieve better financial results.
As mentioned earlier, investing in different types of stocks from various sectors helps ensure that your portfolio in your investment app experiences fewer fluctuations. For example, a portfolio of a single stock or very few stocks could drop 6% one day and rise another 4% the next day. These strong changes in the prices of individual stocks increase the fear of losing everything overnight and may lead the investor to make rushed decisions or cause sleepless nights.
On the other hand, when you have a well-diversified portfolio across more than one sector and with different types of assets (stocks, bonds, cryptocurrencies, etc.), your overall portfolio movements will be less volatile. That way, you can invest with more peace of mind and take a long-term approach.
Each sector of the economy has different returns in various economic conditions. For example, in 2020, many industries benefited from the crisis caused by the coronavirus, such as large laboratories or technology companies. Currently, with rising oil prices, companies related to crude extraction have benefited. The same occurs in other sectors during different economic events.
Therefore, a diversified portfolio will see constant growth over time despite inflation, recessions, or health crises that affect the global economy. A good example of a well-performing portfolio over time is the All Weather portfolio by Ray Dalio.
Warren Buffett’s rule #1 is never lose money. The best way to achieve this is by diversifying. A particular company may cease to operate or have poor results, causing its stock to plummet. But the economy as a whole, especially the U.S. economy, has shown resilience over time. By avoiding losing money and maintaining your investments over the long term, you can increase the chances of earning good returns.
Investors typically diversify their portfolios by asset classes and determine what percentage of the portfolio to allocate to each. Asset classes accessible with small amounts may include:
Investors can gain more benefits from diversification by investing in foreign stocks because they tend to be less correlated with each other. For example, Chinese stocks performed poorly throughout 2021, while U.S. stocks had a strong year. However, in 2022, the movements reversed, with Chinese companies outperforming American ones so far.
Geographic diversification helps reduce political risks. When a country goes through elections, markets can experience periods of significant uncertainty. Other factors causing market fears include protectionist economic policies, mass protests, or war threats. These events can drive stock prices down. To avoid such risks, it’s best to invest in safe markets located in various parts of the world.
It's important to note that many Chinese, German, Japanese, and Latin American companies are listed on the U.S. stock market, so you can apply geographic diversification from your favorite investment app. For example, with Hapi, you can find hundreds of NYSE or Nasdaq stocks operating globally.
A sector is a large segment of the economy made up of multiple industries. Sectors are generally considered broad classifications, such as manufacturing, finance, or technology. Within each sector, several subsectors and industries can be defined. An industry is a specific group of companies that produce the same types of products or services.
A well-diversified portfolio should not have too many investments concentrated in a single sector or group of related sectors to reduce the portfolio’s risk.
Diversification is not as difficult as it seems! To reduce the risk of your investments, you can invest in different sectors, in multiple countries, and in various types of assets. This brings multiple benefits, such as fewer fluctuations in your portfolio, good returns despite economic crises, and, in general, better long-term performance.
You may be wondering at this moment, how can I invest in many sectors and different stocks if I’m just starting to build my portfolio? The answer is to use an app to trade stocks, ETFs, and cryptocurrencies without minimum amounts. We’re happy to tell you that Hapi offers all that and more. That way, you can build a diversified portfolio right from the start and with ease.
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