How to diversify your investment portfolio (a beginners guide)

These are just three tips to get your started! But before you read these any further I  feel that I should address the actual definition of ‘diversification’. It is easy to lose sight of the purpose of diversification and get too caught up in the details- the definition goes some way to limit those problems. In its simplest form diversification means to ‘make or become more […] varied’, to be diverse is to ‘show a great deal of variety’, both of which have to be bared in mind when diversifying your investment portfolio.

1. In the spirit of absolute variety, the first tip for diversifying your investment portfolio is to diversify it both between and within asset categories. Owning stocks in one specific sector shouldn’t make up your entire portfolio – you need to protect yourself against a dip in an individual industry and equally you need protection against things like a recession (apologies for the buzz word) keeping money in steady asset classes are a good way to do this.

2. The best theory I have read for how to divide your money between investment categories comes from www.nolo.com

“Set aside enough money in cash and income investments to handle emergencies and near-term goals.

Next, use the following rule of thumb: Subtract your age from 100 and put the resulting percentage in stocks; the rest in bonds. In other words, if you’re 20 years old, put 80% of your assets in stocks; 20% in bonds. (Most 401(k) plans contain both stock and bond offerings; you can also buy these investments through an IRA.)

Then, in order to diversify your money among the other investment categories, adjust the percentages that you got using the above rule of thumb as follows:

Invest 10% to 25% of the stock portion of your portfolio in international securities. The younger and more affluent you are, the higher the percentage.
Shave 5% off your stock portfolio and 5% off the bond portion, then invest the resulting 10% in real estate investment trusts (REITs). Real estate investment trusts are a hybrid investment that produces stock-like average returns, although a large portion of the return is in dividends. The securities are volatile, swinging wildly in value. But, because they move at such a different pace than other investments, they can actually help stabilize returns”.

Kathy Kristof How to Diversify Your Investments — An Easy Rule of Thumb

3. A good way to diversify is through mutual funds. Basically you’re putting your money in the same pot as other investors and the mutual fund company invest it for you in different asset categories. This somewhat limits the expense of diversification and is a great shortcut to a very diversified portfolio. There are certain risks involved with mutual funds, but they generally have to be addressed on a case by case basis. It’s definitely worth doing your homework before giving your money to a mutual fund company.

A good thing to remember is that when it comes to investment, risk and reward go hand in hand. Diversifying your portfolio does reduce your risk – but you might stand to lose some of your reward too! Think about what is most important to you.