A well-diversified portfolio will typically contain a mixture of these assets spread across different regions and industries.
Here, we examine some of the most effective methods for diversifying your portfolio and explore the potential benefits of doing so.
Why You Should Diversify Your Portfolio
When discussing the topic of diversification, experts are fond of using the phrase “you shouldn't put all your eggs in one basket”. While this may sound like a cliché, there is certainly truth to it.
If you invest all your funds in one company or sector, you could suffer significant losses if the value of that company or sector suddenly falls. Remember, the market can turn for any number of reasons, such as war, political upheaval, or the collapse of a major financial institution.
By spreading your funds across different types of investments (known as asset classes), you’ll have greater protection if a sudden downturn hits one asset class. In simple terms, you may suffer losses, but they may not be as severe.
Four key benefits of diversification
Protects against individual company failures
Having a well-diversified portfolio means that you avoid over-investing in any single business. However confident you are in a business’ leadership team or products, history tells us that any business could suffer a shock collapse.
Lessens the impact of region-specific events
By diversifying your portfolio, you may be able to shield yourself against any risks specific to a certain region. Imagine you hold all your investments in companies headquartered in a certain country. The value of your portfolio could drop significantly if the country’s government suddenly collapses.
Diversification is a proven long-term approach
When you’re looking at financial markets, it is helpful to consider their behavior over the long term. This way, you could avoid placing too much emphasis on temporary ups and downs. Over time, well-diversified portfolios tend to perform better than those that focus heavily on one asset class or sector.
Provides peace of mind
As investments often involve significant sums of money, it is perhaps inevitable that you’ll become emotionally involved in your portfolio. And of course, you’ll likely become anxious if you suffer major losses.
Having a well-diversified portfolio will reassure you that you aren’t as vulnerable to unforeseen events. This sense of reassurance can be especially valuable if you aren’t used to market volatility.
How You Can Diversify Your Portfolio
Choosing the right balance for your portfolio will, of course, depend on your circumstances. However, the steps below are good practices when building a healthy spread of investments.
Consider managed funds
Managed funds are one of the most popular ways for non-expert investors to access a well-diversified selection of investments.
These are collective investments, which means your money will be invested alongside other people’s funds. In most cases, these investments are split across different asset classes and geographical regions.
Examples of managed funds include open-ended investment companies, unit trusts, and investment trusts.
Managers publish information about the spread of investments in their funds. Reading this before you invest can help ensure that you are comfortable with the level of diversification.
Try not to get spooked by market downturns
When you’re investing in financial markets, it’s easy to become anxious when faced with temporary market lows. This could lead you to pull out of your existing investments or to stop investing entirely. While this anxiety is entirely understandable, it could make it difficult to build a well-diversified portfolio over the longer term.
One possible way to avoid this is to consider the dollar-cost-averaging approach. Using this strategy, you commit to investing the same amount of money in your portfolio over set periods of time, regardless of market conditions.
This approach can help you avoid mistiming the market, i.e. buying too many stocks when prices are either high or low.
Thoroughly research your investments
Before you can achieve a truly diversified portfolio, it’s important that you understand the nature of all of your investments.
There may be little value in investing in a range of companies or funds that all have the same underlying risks. An example of this could be investing in a selection of businesses in the same region or sector. In this case, all your investments could suffer losses if there is a downturn in one sector or country.
Likewise, there may be little benefit to investing in a range of funds if all your fund managers are selecting similar types of investments.
Consider physical and non-physical assets
While we tend to think of investments as non-physical assets such as shares in companies, tangible assets can also form part of a well-diversified portfolio. Some of the most popular examples include real estate and precious metals, such as gold.
Let’s take gold as an example. Because gold doesn’t have strong links to other types of assets in financial markets, it is often less vulnerable to major downturns. As a result, it can be a useful safe haven for investors wishing to smooth out risks across their portfolios.
As a longer-term trend, the price of gold has typically moved in the opposite direction to the dollar. In simple terms, a strong dollar means a decrease in the price of gold, and vice versa.
For this reason, many investors will use gold as a way of protecting against high inflation (known as hedging). When inflation is high, prices will rise and the value of the dollar will plummet. In this scenario, gold prices tend to increase.
Different Ways of Investing in Gold
As discussed, gold investing is a popular option for those wishing to diversify their portfolios. While the right investment method for you will depend on your individual financial objectives, listed below are some of the best ways to buy gold.
Gold IRAs
A gold IRA is a type of individual retirement account that allows you to hold gold and other precious metals as part of your portfolio.
Be aware that you’ll need to hold a gold IRA separately from your other IRAs, and you’ll normally need to set up this product through a broker. Likewise, these IRAs may carry higher fees than other retirement products. These higher fees reflect the costs involved in storing gold.
Gold ETFs
A gold exchange-traded fund (ETFs) is a fund that invests in assets such as gold bullion. Because an ETF is traded on the stock exchange, it can allow you to invest in gold without the responsibilities involved in conventional gold ownership, such as storing the precious metal. Removing the cost involved in purchasing and storing gold also makes ETFs one of the least expensive ways to invest in this commodity.
Stocks in mining companies
Rather than investing in gold directly, you could consider buying shares in companies that mine gold. Investing in mining stocks has the potential to be extremely profitable as many of these businesses often make very high profits and some pay dividends to their investors.
Like any investment, however, this also carries risks if the company performs badly or, at worst, fails.
Gold bars, coins, and jewelry
If you decide to invest in gold directly, you can purchase the metal as bars, coins, or jewelry.
While we often see images in movies of gold as coming in large bars, this may not be the most sensible option for many investors
Selling your gold could prove difficult if a single bar represents all of your investments in gold. Imagine you would like to sell just a portion of your gold investment. This may not be possible without selling the whole bar. In contrast, you could easily sell a selection of gold coins or jewelry, while holding onto the rest of your gold.
You’ll also need to consider how, and where, you’ll store your investment. Home storage and depositories are popular options. There will, of course, be important security considerations if you store your gold at home. You’ll likely need to make sure that your gold is in a secure location such as a safe.
In addition, you should consider the increased insurance costs involved in storing gold on your premises. Having gold on your property could put you at increased risk from home invasions.
Given these considerations, you may feel more comfortable storing your gold at a depository or vault. Alternatively, a safety box at a bank may be more sensible if you have only purchased a small sample of coins or jewelry. Bear in mind, however, that you’ll likely need to pay annual costs and fees if you store your gold outside of your home.
The Price of Gold
Gold bullion is traded according to a value in dollars and cents per ounce. With steady price increases over the past 50 years, the metal is traditionally one of the best-performing commodities for investors.
Prices hit an all-time high of $2,074.88 in August 2020 and again reached more than $2,000 per ounce in March 2022. However, prices declined for much of 2022 following the outbreak of war in Ukraine. During 2023, they have again started to increase and the price of gold as of March 2023 stands at around $1,994 per ounce.
It is, of course, impossible to predict future gold prices with total certainty. Nevertheless, many experts forecast that the price of gold will remain strong for the remainder of 2023 because investors see gold as a means of safeguarding against volatile markets.
As already discussed, however, there is a strong link between gold prices and the strength of the US dollar. During the next 12 months, investors in gold would be wise to keep a close eye on any interest-rate decisions from the US Federal Reserve. These decisions will likely have a significant impact on the strength of the dollar and therefore the price of gold.
If the Fed continues to increase interest rates as it has done so far this year, this could lead to a stronger dollar and decreasing gold prices. In turn, lower rates could lead to a weaker dollar and an increase in gold’s value.
Conclusion
Investing in financial markets can bring attractive long-term returns and help you build a nest egg for the future.
Nevertheless, this strategy also carries risks, and markets can be unpredictable. While it is impossible to avoid risk entirely, a well-diversified portfolio could mean you are less vulnerable to temporary market shocks. For many investors, precious metals can be a useful way to guard against inflation and diversify other less tangible assets such as bonds.
Whatever you include in your portfolio, it can be helpful to seek the advice of a professional if you have any questions or concerns. These experts should be able to fully explain the potential risks and returns on your investments.