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What is diversification and why does it matter?

When it comes to investing, one of the most important principles is portfolio diversification. Diversifying your investment portfolio means spreading your money across a range of assets to reduce risk and maximize returns. Below are five reasons why diversifying your portfolio is essential.


Why diversification matters…

Here are five reasons why portfolio diversification is essential: 

  1. Minimize Risk: Portfolio diversification helps to reduce the risk of losing money in the event that one of your investments fails or performs poorly. By investing in different assets, such as stocks, bonds, private real estate, private equity, private infrastructure and commodities, you spread your risk across different markets and reduce the impact of any one investment on your overall portfolio. Managing risk is an often-overlooked part of an individual’s financial plan and for the most part many individuals are taking much higher risks than they even realize. This can come in the form of buying individual stocks, investing in the newest fad or hottest ETF, and/or having a home country biasThe last is rather common, with many individuals putting the majority of their liquid net worth into U.S. stocks. It’s common to look at the preceding 10 years of extraordinary returns and assume this will happen into the future. But, what if I asked you: what were the returns in the U.S. from the 2000 to 2010? It was a total return of 0%, including dividends. So if you had your money exclusively invested in the U.S. over that 10-year period, you would have made nothing.  This fact surprises many investors and is the reasons investors need to be thoughtful and active in the diversification of their portfolios. 
  2. Maximizing Returns: Diversification can help in maximizing your returns. By spreading your investments across different asset classes, you can benefit from different market trends and take advantage of opportunities in different sectors. 
  3. Protection against Inflation: Inflation can erode the value of your investments over time, but diversification can help to protect your portfolio against the impact of inflation. Investing in assets that are likely to perform well during periods of inflation, such as real estate, infrastructure and commodities, can help to preserve the value of your investments.
  4. Liquidity: Diversifying your portfolio can also provide greater liquidity, as you will have a range of assets that can provide income, growth, and potentially be bought and sold. This can be especially important in times of market volatility or economic uncertainty.
  5. Peace of Mind: Diversification can provide peace of mind, knowing that your portfolio is not reliant on the success of one single investment. By investing in a range of assets, you can feel more secure in the knowledge that your portfolio is protected against unexpected events or market downturns.

Regardless of how you decide to diversify your investments, it’s important to remember is that diversification doesn’t guarantee returns or protect against loss. It simply helps reduce your overall risk. That’s why it’s important to develop a long-term plan and periodically review your investments to ensure that they are still meeting your goals. With the right strategy in place, you can maximize returns while minimizing risks. 

Ways to diversify your portfolio

Diversifying a portfolio is an essential risk management strategy that involves spreading investments across different asset classes, sectors, and geographical regions. By diversifying, you aim to reduce the impact of individual investment risks and increase the potential for stable returns. Here are some key steps to diversify a portfolio effectively:

  • Asset allocation: Allocate your investments across different asset classes, such as stocks, bonds, cash, private real estate, private infrastructure, private equity and commodities. The specific allocation will depend on your financial goals, risk tolerance, and investment horizon. Different asset classes tend to have varying levels of risk and return potential, so diversifying across them can help balance your portfolio.

  • Consider investment styles: Diversify within each asset class by considering different investment styles or strategies. For example, in the stock market, you can have a mix of growth stocks and value stocks, or large-cap stocks and small-cap stocks. In private markets, this could mean having allocations to private real estate, private debt, and private equity. This approach helps you benefit from various market conditions and reduces the reliance on a single investment approach.

  • Geographic diversification: Invest in different countries and regions to reduce geographic concentration risk. Economic and market conditions can vary across countries, so diversifying globally can help mitigate the impact of localized risks. Consider investing in international stocks, bonds, or funds that provide exposure to different regions.

  • Sector diversification: Allocate investments across different sectors or industries. Different sectors perform differently based on economic cycles, market trends, and other factors. By diversifying across sectors, you can reduce the impact of poor performance in a specific industry and take advantage of growth opportunities in others.

  • Consider investment vehicles: Diversify your investments by using various investment vehicles, such as individual stocks, mutual funds, exchange-traded funds (ETFs), private investment vehicles, and bonds. Each vehicle has its own risk profile and return characteristics, so spreading investments across them adds another layer of diversification.

  • Rebalance regularly: Regularly review and rebalance your portfolio to maintain the desired asset allocation and diversification. Over time, certain investments may outperform or underperform, causing your portfolio to deviate from your intended allocation. Rebalancing involves selling some investments that have become overweight and reinvesting in underrepresented areas to restore the desired balance.

  • Consider alternative investments: Explore alternative investments beyond traditional asset classes, such as private equity, venture capital, private infrastructure, real estate investment trusts (REITs), or commodities. These alternative investments often have a low correlation with traditional stocks and bonds, providing additional diversification benefits.

  • Risk management: Evaluate and manage risks within your portfolio. Consider using risk management techniques like hedging strategies, options, or diversifying across investment strategies with different risk profiles. This can help mitigate downside risks and protect your portfolio during market downturns.

  • Stay informed and seek professional advice: Monitor market trends, economic indicators, and investment performance. Stay informed about changes in the investment landscape and adjust your portfolio accordingly. If needed, seek guidance from a financial advisor who can provide personalized advice based on your specific financial goals and risk tolerance.

Remember, diversification does not guarantee profits or protect against losses, but it can help manage risk and improve the overall resilience of your portfolio. The specific diversification approach will vary based on individual circumstances, so it’s important to align your diversification strategy with your financial goals and risk tolerance.

Today is a great day to start. If you are looking for ways to diversify your investments and compound your wealth as part of a well-diversified portfolio, review open investment offering HERE.

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