Diversification of the investment portfolio
The advice not to put all your eggs in one basket is known even to people who are far from investing. And if, in general, the rule does not cause controversy, then with regard to more detailed instructions on how to lay out, how to properly diversify your investment portfolio, there is no single correct solution.
Each investor has his own strategy, his own distribution criteria. And their correctness or fallacy is found out only after the fact. Therefore, there will be no ready-made solution in the article. We will only talk about the principles by which diversification can be built.
Why do we need diversification
Everything is very simple. No one can accurately predict the future. Even a deep market analysis does not guarantee success. From time to time, sudden unplanned events occur which fundamentally change the market.
To secure your finances, to insure yourself against losses in the event of negative events, you need diversification.
Greater security in diversification is achieved due to the fact that different events affect sectors and individual enterprises in different ways. And what for one is a collapse, for another it is a time of rapid growth.
Plus, when the funds are distributed, the investment that has become unsuccessful has less effect on the overall result of the entire investment portfolio.
At the same time, diversification for the sake of diversification is also not a good solution. A large number reduces the quality of the analysis of the quality of individual securities. The likelihood of a wrong decision increases.
Diversification by asset class
One way to diversify is to engage in different asset classes. In addition to stocks and bonds, it makes sense to pay attention to futures and options. By distributing funds between them, you protect yourself from systemic risks.
It is also recommended to diversify your investments by currency.
Diversification by sectors
The essence of diversification is to pick up assets in different sectors that have little correlation with each other.
As an example, let us consider the S&P 500 stock index. It includes the 500 largest capitalization companies traded on US exchanges.
They are divided into 11 sectors:
- IT
- Health care
- Financials
- Communication Services
- Consumer Discretionary
- Industrials
- Consumer Staples
- Utilities, electricity
- Real estate
- Energy (i.e. oil and gas sector)
- Material
These sectors behave differently, have different marginality, cyclicality, sensitivity to inflation and central bank rates. Therefore, the share of sectors in the index changes regularly in order to balance the overall weight.
Commodity sectors are doing well in a situation of stability. But are vulnerable to a recession.
Investments in high-tech sectors are investments for the long term.
Since now such companies do not pay large dividends. The bulk of their funds go to research and development. Shares of such companies are also called growth stocks.
When diversifying, it is worth understanding the characteristics of growth stocks and dividend securities and, of course, balancing them in your portfolio.
The opposite of them is dividend papers. As a rule, this is an established business. There is no potential for explosive growth, but there is a stable income.
Adjustments
The market is constantly changing, therefore, no matter how balanced the investment portfolio is, it is recommended to review its structure at least once a year, taking into account market conditions as well as paying attention to your investment strategy.
If you do not have the ability or sufficient knowledge to form a portfolio on your own, it makes sense to turn to professionals for help. Now there are many ready-made solutions on the market for various models of portfolio formation - mutual funds, exchange-traded ETFs, structured products, etc.