How investment diversification helps protect your portfolios from market volatility
What's the story
Investment diversification is one of the most basic strategies to mitigate risk in financial portfolios.
By diversifying investments across different asset classes, an investor may eliminate some of the effects of volatility in the market.
It is a way to balance the return potential with levels of acceptable risk.
Knowing and applying the right diversification strategies can be the key for beginner and veteran investors alike to protect investments from unexpected market changes.
Allocation strategy
Asset allocation across classes
Asset allocation is all about dividing investments among different asset classes, like stocks, bonds, and real estate.
The strategy intends to spread out risk and reward by varying the proportion of each asset class depending on an investor's risk tolerance, goals, and investment horizon.
For example, younger investors could put more toward stocks for growth potential, while older ones might go for bonds for stability.
Global reach
Geographic diversification
Investing in international markets like the US exposes you to growth opportunities beyond your own country.
Geographic diversification limits dependence on the performance of a single economy.
Investing in both developed and emerging markets can help you capture different economic cycles and enhance returns while reducing the risks of domestic downturns.
Industry spread
Sector diversification
Sector diversification means putting your money in different industries or sectors of the economy.
This way, you are protected from sector-specific downturns that might affect your portfolio if concentrated in one area.
For instance, a combination of technology stocks with healthcare or consumer goods can act as a buffer if one sector underperforms due to industry-specific challenges.
Fund strategy
Use of mutual funds or ETFs
Mutual funds and exchange-traded funds (ETFs) are ideal investment tools with built-in diversification.
They pool money from several investors and invest in a wide range of securities.
These funds are managed by professionals who spread assets across sectors or regions based on certain investment goals.
They allow individual investors to have diversified exposure without having to know a lot about the market.
Alternative assets
Incorporating alternative investments
Alternative investments are those assets, like commodities, real estate investment trusts (REITs), or private equity, that don't belong to traditional categories like stocks or bonds.
Having alternatives in a portfolio can provide other layers of diversification since the assets tend to have low correlation with traditional markets.
This means they would perform differently in the same economic conditions, providing potential stability during market volatility.