When considering how you can diversify your portfolio to achieve greater or more stable returns, it is important to remember that diversification should be done on a variety of factors, such as geography, industry, market capitalization and asset class. In this article, each of these facets of diversification are outlined to provide extra clarity on how one can diversify their portfolio across each delineation.
If you are a U.S. resident, it might be tempting to invest your savings into some strong American companies. However, you would not be protected if there is a decline in their NYSE or NASDAQ or if there is a negative economic event that affects all American companies. Examples of this include the increasing political and economic instability in many developed and developing countries which make the concept of not “putting all of your eggs” in one basket or one country even more prescient today. You can keep up to date on these issues and their economic impacts by following websites like Seeking Alpha or Bloomberg.
It is good to have a mix of cyclical and defensive industries in your portfolio to ensure that you achieve a steady return regardless of the economic environment. Cyclical industries like the auto industry or consumer discretionary will perform better in a good economy while defensive industries like mining will perform better in a poor economy. By having a balance of these types of stocks, you can achieve a more stable return so you can sleep easier at night.
Larger companies tend to be more stable but often will grow at a smaller rate than small cap companies which are worth less but can sometimes have much greater growth potential. Finding a balance between companies of different sizes will help you achieve a diverse portfolio.
While some people stick to stocks and bonds, there are many other asset classes to choose from which can help you achieve greater balance in your portfolio. Ask your financial planner about ETFs, mutual funds, options, futures, warrants or other derivative products that might be suitable for you and your investment needs.
It’s clear that having a well diversified portfolio is something that needs to be well thought out and structured strategically. In addition, instead of simply diversifying based on industry as people typically did in the past, in today’s economy a more multifaceted approach to diversification is necessary to ensure that you are generating returns that are superior to the market. With these tips, you’ll be on your way to constructing a great portfolio in no time!