Diversification is a mandatory part of working with investments for both beginners and experienced investors. It provides security, reduces risks and reduces dependence on market fluctuations..
We tell how to diversify the portfolio, where to start, which model to use and what to pay attention to, so that risks are reduced and profits grow.
Why asset diversification is needed
The term “diversification” is derived from English diversity, which means “diversity.” Hence the main principle – the investment portfolio must be made “wide”, that is, buy several shares and bonds, and not invest in only one asset or one sector of the economy.
Why is diversification useful? Imagine three scenarios:
- You have a portfolio of 150,000 rubles, which consists entirely of shares in oil companies. Under the influence of negative factors, the entire industry falls in value by 20%. Your portfolio is also depreciating – from 150 thousand to 120. This is a serious blow..
- The portfolio consists of 50 thousand – of bonds, and 100 000 – of oil shares. Here, if you fall by 20%, you will lose less – only 20, not 30 thousand.
- Portfolio composition: 50 thousand – bonds, 25 – oil companies, 25 – medical, 25 – ferrous metallurgy, 25 – consumer goods. In this case, with a similar drop in the oil market by 20%, losses will amount to only 5,000 rubles.
In addition, a decrease in the price of one asset is offset by an increase in another or several others. This not only prevents the portfolio from losing value, but also ensures its growth.
Thus, the more diverse the assets, the calmer the investor is experiencing a fall in the price of some of them.. Of course, the collapse of the entire global economy can happen, but this rarely happens. Serious problems sometimes arise in individual sectors, directions or companies. When this happens, an investor with a diversified portfolio is cold-blooded. He does not lose a lot of money, because other investments pay off the recession.
Asset Allocation Strategy
Over time, each investor develops his own approach to how many assets of a particular type he wants to have in his portfolio. Such things are formed through practice, personal risk appetite and understanding of one’s investment temperament. Therefore, copying someone’s strategy (even a very successful investor) is wrong. It is important to start with the basic model, and then, gaining experience, adapt to yourself.
General principles
Good diversification involves diversity at all levels:
- Currency. You must have funds in foreign currency. Best of all – in the reserve, because it is usually more stable than the national one (pound sterling, US dollar, euro, Swiss franc, Chinese yuan, Japanese yen). Choose the one you handle most often and place a smaller portion of the capital there. For example, 30%. So, you don’t have to often transfer money and lose at exchange rates.
- Types of assets. The portfolio should include assets with both high (stocks) and low (bonds) risk. The former are more profitable in the long run and provide growth. The latter provide little profit, but protect against severe drawdowns..
- Industries. It happens that in some areas of the economy, all stocks begin to decline, while in others the situation persists or things are going uphill. Therefore, select assets from different industries.
- Companies. It may turn out that with a general positive trend in the industry, the shares of a particular company are losing value. In a diversified portfolio, this decline is offset by the success of other companies..
Summary. A diversified portfolio has assets of various types that relate to various industries. The wider the variety – the less chance that the fall of one of the positions will significantly affect the entire portfolio.
Bonds
With this type of securities, everything is simple. Bonds should be in the portfolio a percentage equal to the age of the investor:
- 25 years: 25% – bonds, 75% – shares.
- 40 years: 40% – bonds, 60% – shares.
The fact is that the ratio of bonds to shares in the portfolio is a reflection of risk appetite. Stocks are a big profit and a big risk. Bonds mean low profit and low risk.
The older the person, the more important it is for him to keep the money earned, so with age, the risk must be reduced. In youth, there is time for correcting mistakes and restoring capital. Therefore, you can take more risk for better profit..
Remember that this is a basic recommendation on the ratio of securities. If you already have a good tolerance for risk and are ready to create a more risky or stable portfolio – adapt to yourself.
Stocks
Analysts say well-diversified portfolios contain 10-14 securities. You can deviate from these numbers when you are confident in your actions, but do not forget:
- If the portfolio has less than 10 securities, it becomes too risky.
- If the portfolio has more than 14 securities, it does not receive additional benefits from diversification and loses in profitability. In addition, it becomes more difficult to manage..
As already mentioned, diversification involves the purchase of shares not only of different companies, but also the investment of money in several sectors. If you plan to purchase 14 securities, choose from 7-8 areas of the economy. Try to make sure that all companies account for approximately the same amount of investment. Investing half of the money in Rosneft and sharing the rest between 10-12 other companies is a bad approach.
How to diversify a portfolio: step-by-step instructions
Based on the advice presented, we will analyze how to diversify a portfolio wisely with a capital of 500,000 rubles:
1. Convert a portion of capital to currency. Let’s say 150,000 rubles (30%) – in dollars. They can be stored on deposit or invested in foreign assets (a dollar portfolio must be created and diversified separately from the ruble).
2. Buy bonds. If you are 30 years old, they should be 30% – 105,000 rubles.
3. The remaining 245,000 rubles invest in shares. Pick up 10-14 companies from 6-8 industries and invest in them. The share of each asset in the portfolio should be 18,000-25,000 rubles.
This is an easy way to diversify your portfolio. In practice, capital can also be real estate, precious metals, mutual funds, ETFs, venture projects. In this case, it is also necessary to diversify, taking into account the potential profitability and risk of each of the assets.
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Can you please share some practical strategies or tips on how to effectively diversify a portfolio? What are some key factors to consider when selecting a diverse range of assets?