It is wise not to put all of your eggs into one basket in the world of investing. Putting all of your money into a single stock could wreak havoc on your wallet if that particular company or its business sector goes bankrupt. For this reason, financial advisors often talk about the necessity of portfolio diversification. But how do you go about diversifying your portfolio properly?
Studies show that only 15 different stocks are enough to build a portfolio with an optimal risk/reward ratio. For effective diversification, you have to ensure you're your stocks’ prices don’t all react the same way to events affecting the market. A recent example is the 2009 fall of the big three automakers, Ford, Chrysler and General Motors in the North American automobile world. An investor having diversified their portfolio only with stock in these three companies would have seen their money go out the proverbial exhaust pipe.
It is therefore important to properly diversify your portfolio, and the Hardbacon application can help you do it. Using the application’s diagnostic function, you can find different diversification indicators.
Diversify asset categories (Stock allocation and Diversification in the app)
A stock category contains stocks with common characteristics, and each category has a different remuneration method and is subject to different risks. The most known classes of securities are stocks, bonds, cash and even real estate. For example, stocks will fluctuate based on the economic conditions while bonds depend upon the interest rate. By combining different categories of investments, the gaps in returns and exposure to risks will be reduced.
Invest in different business sectors (economic cycles in the app)
Prices for stocks in the same business sector will often fluctuate similarly. Let’s consider again the example of General Motors in 2009. Adding Ford and Chrysler stock wouldn’t have prevented your portfolio’s value from falling. Therefore, having stock in other sectors such as financial services, energy or even raw materials would have helped minimize the impact on your portfolio.
Invest in different geographic regions
Stocks from different countries don’t fluctuate in the same manner. Each region of the world has a different economic situation, and you can use leverage these differences to minimize risks in your portfolio. After the crisis in 2008, emerging countries bounced back much more quickly than some developed countries. By combining stocks from different regions, those with rising prices will compensate for those that are falling.
A diversification strategy won’t eliminate all risks. Diversification helps reduce the risks inherent in stocks, business sectors and geographic regions. If the global economy tumbles like it did during the 2008 economic crisis, it is very likely that a very well diversified portfolio will also suffer.
Lastly, it is necessary to keep an eye on your portfolio’s performance to ensure that your financial objectives are accomplished. In order to do so, Hardbacon offers you its mobile application that will help you make the best investment decisions.
If you liked this article, you’ll like the Hardbacon application even more. It links to your investment accounts, analyzes your portfolio and helps you make better financial decisions. As a loyal reader of our blog, get a 10% discount off a Hardbacon subscription. To take advantage of this promotion, use the promo code BLOG10 when subscribing through our website. https://staging.hardbacon.ca/en/app/