Diversifying is a very important aspect of investing. No matter how good you are at stock picking, you cannot win every time. There is always information you don’t have access to and that might cause one of your positions to go in the wrong direction.
This post is focused more towards picking individual stocks. Investing in already diversified index funds or ETFs doesn’t require you to put in so much effort towards diversifying. However, even when investing in index funds or ETFs, you can still diversify. Time diversifying and geopolitically diversifying your investments is one aspect to consider.
Diversify risk without sacrificing returns
If you happen to find a great company that you think is undervalued, you can take it as a part of your portfolio. There are other great companies as well, that could match your criteria.
If you decide to go all in on that one company, that might be fatal to your portfolio. There is always information and variables that you don’t either know or have control over. By having a lot of so-called undervalued great companies, you diversify the risk of one or two of them getting hit by regulations or changing word situation.
How many companies should you have in your portfolio?
You can think about it this way: if one company performs poorly, how big of an impact do you want it to have on your portfolio? If one position won’t be more than 10% of your portfolio, if the company goes bankrupt, that doesn’t bankrupt you.
If 10% sounds like too much, go for 5% or less. This means 20 or more different companies to have in your portfolio.
Sometimes it is difficult to buy so many different stocks, if the fees for buying individual stocks are high. If this is the case, and you have just smaller amounts to invest, index funds or ETFs could be a better alternative for you.
However, if you wish to build up your own portfolio with smaller initial capital, it might make sense to find a broker that offers cheaper fees.
So, back to the initial question, how many companies should you have in your portfolio? Make clear rules that the buying price of certain companies should not be more than 5 or 10 percent of your total capital.
This way, it doesn’t mean you have to sell some of your positions if they go beyond that. You don’t want to kill a milking cow, but it doesn’t let you lose more than the fixed amount on a single position.
This is another way to diversify your portfolio. It can be done whether you invest into straight stocks and also if you are more of an index fund or ETF investor. You can pick stocks and funds from different parts of the world.
This could mean having a certain portion of your portfolio in US stocks, some in emerging markets, some in European stocks and so on. It is all up to you, and this is not necessary. Usually, if stocks dive in the US, the rest of the world will follow along.
Diversifying into different industries
It might be a good idea to not keep your entire portfolio on stocks that all are dependent on the same resources or customers. Have stocks from different industries, so the changes in one industry won’t affect your portfolio so heavily.
You can keep a higher weight on certain industries, if you have strong faith in them. You also do not have to invest in all of the industries out there. Diversifying among different industries is a good way to balance and get some extra safety to your portfolio when done right.
Time diversifying is also another way of diversifying. This means buying more assets regularly, instead of pouring all of your money into the markets right away or waiting the market to fall until you buy.
In simple, this can be done by just putting a fixed amount of your salary into investing each month. No matter what is happening at the market at the time, you will be there to buy.
Alternative investment opportunities
News flash: there are other investing possibilities than stock market. You can invest in real estate, commodities, Pokémon cards or even cryptocurrencies if you feel like taking some extra risk.
All the assets mentioned and a lot more can be considered as investments, if you can expect returns from them. You don’t have to keep all your assets as stocks. There are other ways to invest as well. It’s just that stocks can be the easiest ones to invest, since you can buy them all in the same place and don’t have to find a tenant for your property, for example.
I’m sure everybody has their views on what is the best way to diversify. I would say that overdiversifying is seldom the problem. More times the lack of diversifying becomes an issue. Maybe the stock you put all your money at doesn’t bring those sweet 100% annual returns that a guy on the internet promised.
Also keep in mind that I’m just another guy on the internet telling my opinions on diversifying. It is really up to you what kind of portfolio you want to have.
Hopefully this post helps you find the best way to diversify. Have a nice day.
Other investing-related posts can be found here.
This is not investment or financial advice. Past returns are not a guarantee of future returns. Always do your research before risking your hard-earned money.