The modern portfolio theory states that 15-20 stocks from different sectors are sufficient to make a well-diversified portfolio.
What is Diversification?
Diversification is the practice of expanding your investments in a manner that the exposure to any single type of asset is limited. It is a struggle for many financial planners, individual investors and fund managers alike. During the time of the market boom, it seems unfair to sell a stock for any amount less than the price at which you bought it. A boom in the market looks very appealing and as such investing in equities seems like the best idea, but a well-diversified portfolio is needed because we can never be sure of how the market will behave at any moment.
Here are five tips to diversify your portfolios:
1. Consider bonds or index funds: Apart from all the funds out there in the market, it is advisable to add index funds or fixed income funds to the existing funds. Investing in securities that track different indexes make an amazing long-term diversification investment for your portfolio. Your portfolio is further hedged against market volatility and uncertainty by adding some fixed-income solutions.
2. Keep building your portfolio: Make sure regular additions are made to your investments. If you have money to invest in dollars, use dollar-cost averaging. This technique is used to even out the ups and downs created by market volatility. This also enables you to invest money consistently into a specified portfolio of securities.
3. Keep a watchful eye on commissions: If you don’t understand trading very well, make sure you at least understand what you are receiving for the fees you are paying. There are some firms who will charge you on a monthly basis whereas there are some who will charge you a transaction fee. Make sure you are alert and know what you are paying.
4. Spread the wealth: It is important to not put all your money in one stock or one sector, no matter how appealing equities may seem. It is better to create your own virtual mutual fund by investing in a handful of companies you know and trust. These could also be the companies whose product you use on a daily basis, or you hear about every day. Knowing a company and its products can be a healthy and beneficial approach to this sector.
5. Know when to get out: Just because you are good at buying, holding and dollar-cost averaging and have your investment on autopilot, it does not mean you should not recognise the signs of pulling the plug. It is important to be aware of the change in market conditions and take the necessary steps when required.
While these are just some of the factors that help to diversify the portfolio, there are many other underlying factors that can be added to the list. Portfolio Diversification is an essential component while investing and identifying the need for it and applying them at the correct time is critical.