Diversification boils down to a straightforward principle: don’t put all your eggs in one basket. Instead, spread your investments across a mix of assets to balance risk and reward. Think of it like building a team — each player has a role and different characteristics. Some may perform better against certain teams, while others excel against different opponents. Building a great team requires lots of planning and finding players with different strengths. In addition, you may not want to use the same strategy in every single game.
Diversification is often considered solely to be across different sectors. However, this is only part of the game. In this article, we are going to explore what type of aspects diversification holds. You can utilise this list to analyse your investments from a different perspective. Are you actually diversified?
The idea is not to encourage you to diversify your investments based on every single point mentioned but rather to provide you with ideas on the types of methods that exist. This way, you can find the ones that help you achieve your financial goals.
Diversification across investment opportunities
Let’s start with the basics. You may have a favourite player on your team that you’re rooting for. However, you most certainly don’t want every single player in the team to be an exact clone of that favourite player. Right?
- Asset Classes:
Diversify across different types of assets, such as stocks, ETFs, funds, bonds, futures, commodities and options. - Geographical Diversification:
Allocate investments in various geographic regions to reduce exposure to country-specific risks and take advantage of global opportunities. - Industry Sectors:
Spread investments across different industries to avoid concentration risk. This helps mitigate the impact of poor performance in a specific sectors. - Company Size:
Include large-, medium and small-cap stocks in your portfolio to balance potential returns and volatility. - Currency Exposure:
Consider currency diversification, especially for international investments, to hedge against currency risk. - Correlation:
Understand the correlation between different assets and adjust the portfolio to include assets that don’t move in lockstep with each other.
Diversification across investment strategies
Markets can be unpredictable. Depending on the market environment, different types of strategies may thrive, while others lose their power. To name a few factors affecting this dynamic: Interest rates, inflation, economic conditions, geopolitical events and central bank policies. Different opponents require different strategies. You don’t have to stick with one, incorporate the ones you find suitable for your financial goals.
- Value Investing:
Focus on undervalued stocks with the potential for long-term growth. Investors using this strategy believe that the market undervalues certain stocks and aims to capitalise on their future appreciation. - Growth Investing:
Target stocks of companies with strong potential for high future earnings growth. Growth investors are often willing to pay a premium for stocks expected to outperform the market. - Income Investing:
Prioritise investments that generate regular income, such as dividends and interest payments. Income investors often favour stable, dividend-paying stocks or fixed-income securities. - Dividend Growth Investing:
Invest in companies with a history of consistently increasing their dividend payouts to generate recurring income. - Value Growth Investing:
Blend value and growth strategies, seeking stocks that are both undervalued and have strong growth potential. This approach aims to find opportunities where the market underestimates a company’s growth prospects. - Contrarian Investing:
Go against prevailing market trends and sentiment. Contrarian investors buy assets that are currently unpopular or undervalued, expecting a reversal in market sentiment. - Index Investing (Passive Investing):
Utilise low cost funds and ETFs that track specific market indices, such as the S&P 500. Passive investors believe in the long-term success of the overall market and aim to match its returns. - Momentum Investing:
Capitalise on the continuation of existing trends in asset prices. Momentum investors buy securities that have performed well recently, expecting the trend to persist. - Cyclical Investing:
Adjust investment strategies based on economic cycles. Investors focus on industries or sectors that tend to perform well in specific phases of the economic cycle. - Swing Trading:
Capitalise on short- to medium-term price movements. Swing traders aim to capture “swings” in asset prices and typically hold positions for a few days to weeks. - Day Trading:
Execute multiple trades within a single day, taking advantage of intraday price fluctuations. Day traders close all positions by the end of the trading day to avoid overnight risk. - Options Trading:
Utilise options contracts to hedge, speculate, or generate income. Options trading involves buying or selling options contracts rather than the underlying securities. - Socially Responsible Investing (SRI):
Consider environmental, social, and governance (ESG) factors when making investment decisions. SRI aims to align investments with ethical or sustainable principles. - Contribution strategies:
- Dollar-Cost Averaging: Invest a fixed amount of money at regular intervals, regardless of the asset’s price. This strategy aims to reduce the impact of market volatility and allows investors to accumulate more shares when prices are low.
- Lump sum investing: Lump sum investing involves deploying a significant amount of capital into the market all at once. This method is often preferred when an investor identifies an opportunity, such as undervalued stocks or a market dip.
- Reinvestment of Returns: Reinvesting dividends, interest, or capital gains over time enhances the power of compounding.
Diversification across time
Spreading out your investments over time helps lower risks. Even if the market goes up and down a lot in the short run, the long-term impact of those ups and downs tends to balance out. Using methods such as DCA and reinvesting returns mentioned in strategies section are effective ways to incorporate diversification across time into your investments. This not only mitigates the impact of volatility but also aligns with the principle that time acts as a stabilising force, providing a buffer against the uncertainties of the market.
Diversification across investment accounts
Diversification utilising different investment accounts involves spreading your investments across various financial vehicles, each offering distinct tax advantages, regulations, and features. These accounts may include individual brokerage accounts, IRAs, Employer-sponsored retirement plans, margin accounts, crypto currency accounts, cash accounts etc. Choose accounts for your needs and investments appropriately.
Summary
Diversification in investing goes beyond sectors, as often thought. By utilising different asset classes, currencies, geographical locations, investment strategies, account types and time, an investors can achieve balanced, yet effective investment portfolios.
At Stockle, we value diversification and effectively performing and structured investment portfolios. Therefore we built a platform where investors can truly achieve their highest potential. Diversify, structure, track, optimise and beat the market in your unique investing style.
