Diversification - what is it and why it’s important
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. But while that might give you a portfolio that feels 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
When you diversify your portfolio, you’re spreading your money across different investments. That means your total investment nest egg isn’t weighted too heavily in one thing – so, if your favorite tech stocks suddenly get volatile 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. 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 placed to find new opportunities around the globe.
Holding a well-diversified portfolio does usually also 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.
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
As a starting point, you should consider holding a mix of various asset classes, such as equities, ETFs, bonds and commodities. Via investments in these different asset classes, you can gain further diversification by picking different types of individual investments within the chosen asset classes.
One easy way of doing this is to browse different asset classes and filter out investments based on different criteria. In SaxoTraderGO, you can use the screener function to find individual investments based on filters such as geography, industry, bond issuer and market capitalisation.
Another way of building a diversified portfolio is to apply a thematic investment approach, where you start picking a few investment themes, or long-term market trends, you believe in. In SaxoTraderGO and SaxoInvestor, you can find a big pool of long-term investment themes, which are 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 company sizes, that give you a well-diversified exposure to the theme you believe in.
If you prefer to “buy the entire theme” over investing in single instruments, you can chose to invest in one of the related ETFs, which gives you an instant diversified theme exposure through only one investment.
What is the ideal number of investments?
While there are different opinions about the optimal number of investments in a diversified portfolio, there’s no single correct answer to this question. However, as a general rule of thumb, most investors (both retail and professional) hold at least 15-20 instruments in their portfolio.
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