Diversification - what is it and why it’s important Diversification - what is it and why it’s important Diversification - what is it and why it’s important

Diversification - what is it and why it’s important

Thought Starters 3 minutes to read

Saxo Group

Summary:  When you build a portfolio, it's normal to invest in what you know best - a few tech names you like or familiar stocks from your home market. While that might feel comfortable, it's far from bullet-proof. Why? Because it lacks one key-element: diversification.


What is diversification and why you should diversify your portfolio

Let's get one thing straight, holding one or two stocks doesn’t make for a diversified portfolio. Companies do go bankrupt, think Enron back in 2001, Lehman Brothers in 2008 and Silicon Vallee Bank in 2023. Holding a highly concentrated portfolio can be a recipe for disaster so it is extremely important to diversify your portfolio. To diversify your portfolio means you’re spreading your money across different investments and different asset classes such as equities, bonds and commodities. That way your investment nest egg isn’t weighted too heavily in one thing – so, if your favorite tech stocks suddenly tank or your home market takes a dramatic downturn, your portfolio as a whole won’t be so vulnerable.

Less risk is just one benefit of diversifying your portfolio. Holding a well-diversified portfolio does usually lead to less volatile returns. With only a few investments, your portfolio performance is likely to differ significantly from year to year, while a broader range of investments tends to generate a smoother return development. 

Casting your investing net wider – across the globe if possible – also means you’ll be able to catch more opportunities in the financial markets. 
Remember the skyrocketing Chinese stock markets in 2014-15? Or the Tesla rally in 2020? By flexing your investing muscles and adding a variety of assets, you’ll not only keep your portfolio more balanced, you’ll also be better positioned to find new opportunities around the globe.

How to build a diversified portfolio

Making that initial choice to diversify is the easy bit but identifying what to invest in and the number of investments is slightly trickier.

Identifying what to invest in

There are many ways to build a diversified portfolio. You could invest in a fund (mutual fund or ETF) that gives you instant exposure to a broad range of developed market companies around the world. The search function in SaxoInvestor and SaxoTraderGO can easily be used to find such funds, simply type “world ETF” in the search function and browse through the list of funds from the search result. 

If you prefer to invest in stocks directly, it is recommended to invest in between 20-30 stocks to avoid over-concentration. Additionally, make sure to select companies from different sectors. The screener function in SaxoInvestor and SaxoTraderGO can be used to find stocks. Select a few sectors of your choice (for example technology, healthcare, finance, etc.), as well as any other criteria that matter to you such as countries/regions, market capitalization, analysts’ ratings or ESG risk ratings and finally browse through the list of stocks from the search result.

Essentially, the goal is to hold more than a handful of stocks, invest in various sectors and lastly have a mix of asset classes. Via investments in these different asset classes, you can gain further diversification by picking different types of individual investments within the chosen asset classes.

Another way to build a diversified portfolio is by adding thematic investments to your core portfolio. The idea is to pick one or more investment themes, or long-term market trends, you believe in. In SaxoInvestor and SaxoTraderGO, you can find a big pool of long-term investment themes handpicked for their future upside potential. The themes range from sustainability to digitalisation and come with inspirational investment lists, with instruments spread out across geographies, industries and market capitalizations. You can choose to buy a few names or all the companies listed in the theme as it’s not always easy to spot the next success story.

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