Investment diversification means that an investor should buy investments that are not concentrated into one company, industry, country or even asset class.
You have undoubtedly heard the saying “Don’t put all your eggs in one basket”? The same principle applies to investing – put your investments into different baskets. If some of the baskets should fail then your losses will still be manageable.
It can be tempting to put a large percentage of your portfolio into one stock or investment type that you are convinced will do well, but what happens if you are wrong? Your investment could get wiped out! Spreading your investments into different asset classes, industries, countries and even currencies will help guard against a major loss.
Diversification means different!
If you want to diversify your investments then it is important to ensure you are buying investments which are not correlated with each other – in other words if you buy 3 different oil company stocks then you are not really much more diversified than you would be with 1 oil stock since the factors that affect oil stocks are probably quite similar. If the price of oil drops then that will be a negative factor for all oil companies.
Here are some ways to diversify your portfolio:
- Asset classes – stocks, bonds and cash are all generally not correlated with each other so owning some of each will help diversify your investment portfolio.
- Industry – If you own stocks either directly or in mutual funds then make sure there is adequate representation from different industries.
- Country – Most investors tend to own too much equity in their home country which reduces their diversification.