The importance of diversification
If you’re not completely new to the investment world, you will probably know how much is important to diversify your investments. Today I want to analyze the 5 different dimensions of diversification.
Diversification is one of the most important topic in personal finance and not only. To diversify is crucial in order to reduce the risk related to our Investment Portfolio. The greater the number of assets in your portfolio, the lower the related risk.
Some days ago I watched a super interesting video on Youtube by Ray Dalio, founder of Bridgewater Associates. It talks about the importance of diversification and why we should diversify our portfolio among at least 10 different assets. Check it out, it’s illuminating.
For example, as you can check in the My Investment Portfolio page on this blog, I’m currently investing on many P2P Lending and Real Estate Crowdfunding platforms. Moreover I added to my investment portfolio eToro, which is a social trading platform that allows me to earn by copy-trading other traders, and two platforms that grants me an higher return but are very risky (SolidTradeBank and DiversityFund). Finally, I own stocks of two different companies (CocaCola and Cisco) and my intention is to buy stocks of other companies in the next weeks or months.
I’m working hard on the diversification of my Investment Portfolio. I think that I’m on the right track but there is still a lot to do. First of all, holding stocks of so few companies is not a good thing. That’s why my plan is to invest money on dividend ETFs. I still have to choose on which ETFs to invest, but I’m working on it.
The 5 dimensions of diversification
In order to make diversification more clear, I decided to identify 5 dimensions in which we all should diversify our Investment Portfolio. Remember to always take into consideration these dimensions while you’re preparing your investment strategy and plan.
Diversify according to geography
Remember to invest on stocks/ETFs/whatever based in different countries and continents. Do not invest in only one country, as I’m doing for the moment.
In this way you will reduce your exposure to the specific risk of the country or continent. For instance if the USA market go down, my stock portfolio will go down too. That’s why I should add more stocks based in different countries.
Diversify according for potential growth
On more important dimension of diversification is the potential growth of the stocks of your portfolio. I believe that we should include in our Investment Portfolio both stocks with high potential growth and stock with low potential growth. I think this because the risk related to stocks with an high potential growth is higher compared to the one of the stocks with low potential growth.
Therefore including both the kind of stocks will create an efficient mix and a portfolio with a good annual return.
Diversify according for financial instruments
We should know and include in our portfolio different financial instruments, not only stocks. The reason is always the same. We’ve always to keep into consideration the overall risk of our portfolio. If we invest only in one financial instrument our risk exposure is completely related to that particular instrument, and this is never good.
For example, investing on ETFs and bonds can be a good choice, always remembering the other dimensions.
Diversify according to the stock’s sector
Never invest only on stocks that belong to the same commercial sector. Include in your Investment Portfolio at least 4 or 5 different sectors, possibly low connected to each other.
Just to make a stupid example, I’m currently investing on the beverage and IT sectors, which are very little connected. This means that if one day the IT sector goes down, probably the beverage sector will behave differently.
Diversify according to time
My suggestion is to build a time-diversified portfolio. I mean that we should include long term oriented financial instruments, like government bonds or stocks that we want to hold for many years, but also short term oriented financial instruments, like stocks that we believe could achieve an interesting return in 1 or 2 years for example.
These are in my opinion the five important dimensions of diversification.
Never forget the importance of diversification. Never. It’s absolutely important to your financial success. So always take into consideration these 5 dimensions while you’re defining your Investment Portfolio.
Considering that I need to work a lot on the diversification of my portfolio, I’ll write many articles about this particular topic.
Consider this post a short guide to diversification. A starting point to explore this extremely important topic.
If you want to read more about this interesting argument, I suggest you two books:
- Strategie di diversificazione e creazione del valore, by Fabrizia Fontana (for my italian readers) [Buy it on Amazon.it, 13,50 EUR]
- Portfolio Selection: Efficient Diversification of Investments, by Harry M. Markowitz [Buy it on Amazon.com, $20]
Before leaving, I suggest you to give a fast lecture to the page that I dedicate to the composition of My Investment Portfolio, so you can give me interesting advices on how I can improve it.
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