How to create a diverse portfolio
If you want to diversify your investment portfolio, you can think of your holdings as one large pie made up of different slices, each with its own flavour of risk.
Learning how to diversify your portfolio to suit you as an investor is a foundational skill that everyone should work on. Diversification is a tried and tested method of minimising your losses while ensuring exposure to the best-performing assets. No one can predict the future, so, for many investors, diversity is the antidote. This guide explains diversifying, and how to do it.
Diversifying successfully involves balancing risk against your long-term goals and taking note of what’s happening in the wider world. If this sounds like too much effort, don’t panic – there are ready-made short-cuts you can take, which we’ll explain.
What is portfolio diversification?
Diversifying is the ultimate way to create a healthy balance of risk and reward with your investment portfolio. There’s no “one-size-fits-all” method to achieve a perfect balance but you can adjust how it applies to your investments based on your interests and how much risk you’re comfortable taking.
However, at the core of proper diversification, you should be looking to divide your portfolio holdings across a range of:
- Assets. Equities, bonds, commodities, property, and cash.
- Regions. UK, US, Europe, Asia, Emerging Markets, and Global.
- Sectors. Financials, healthcare, consumer staples, technology, energy and utilities.
- Types. Individual investments, index funds and ETFs (exchange-traded funds), dividend stocks, value stocks, and capital growth shares.
- Sizes. Small-cap, large-cap, and everything in between.
- Alternative investments. Art and antiques, peer-to-peer (P2P) lending, cryptocurrency, memorabilia, and private equity.
This isn’t an exhaustive list, but it should give you an idea of how many options are out there to fully flesh out and diversify your portfolio. You can find templates online to help with diversification. However, these won’t be personal to your goals – so always take them with a pinch of salt.
One strategy you could use to get some inspiration is to research ready-made investment portfolios available with share dealing platforms, and see how each splits up the asset allocation.
For example, you could look at the various IG Smart Portfolios to get an idea. These portfolios from IG have been created using asset allocation guidance from BlackRock (the largest asset management company in the world).
Then, you can treat that as a skeleton frame for your portfolio – using a similar asset allocation but selecting the individual investments that make up the percentages for yourself. This way, you’ll be using a solid structure created by professionals. Yet, it is still tailoring your portfolio to investments that you understand and believe in.
How many assets should you have in a diversified portfolio?
The answer to this depends on what you can manage and are comfortable keeping on top of. Ideally, you should hold at least some of each asset type in your portfolio. Your job is to decide how much of your portfolio you want to allocate to each of those assets.
The value of your portfolio can also make a difference in how many assets you should own. Typically, the larger your portfolio, the greater the number of assets you should invest in and vice versa. If you’ve only got £1,000 to invest, it may not be necessary to spread yourself too thinly across a vast range of assets. Whereas if you have more wealth, for example, £100,000 (or even £1,000,000) – it’s sensible to use more assets.
You’ll likely build wealth over time. So, it can be worthwhile expanding how much you diversify as your portfolio grows. If you own a portfolio completely made up of stocks and shares, this may not lead to complete diversification, but if it’s how you like to invest, that’s up to you.
“A good rule of thumb for a portfolio containing stocks is to keep at least 25 companies made up of different regions, sectors, and sizes.
One easy short cut for this if you don’t want to research and find multiple stocks is to use an exchange-traded fund (ETF) or an investment fund managed by experts. Another alternative if you want a hands-off approach to diversify your portfolio is using a robo-advisor or a ready-made portfolio on an investment platform.”
Examples of a diversified portfolio
To illustrate what different levels of diversity can look like based on your attitude towards risk and reward, below are some examples of how you could choose to diversify your portfolio.
All investing should be regarded as longer term. The value of your investments can go up and down, and you may get back less than you invest. Past performance is no guarantee of future results. If you’re not sure which investments are right for you, please seek out a financial adviser. Capital at risk.
A brief caveat is that we’ve excluded cash from these portfolio allocations to centre purely around investments. It’s always worth having a decent level of cash, ideally 6 months to a year of living expenses as an emergency fund. This way, you have a healthy buffer and can cover all your costs without potentially having to sell any investments if you need money.
Popular asset classes and alternative ways to diversify
You’re not the first person looking to diversify your portfolio. And the great thing about this is that there’s loads of information and data available for you to access freely. To dive a little deeper into some of the most popular ways of diversifying, below is a brief breakdown of various assets that could come in useful.
Exchange-traded funds (ETFs) can act as your secret weapon when you want to diversify broadly without spending a lot of time researching and managing your investments.
ETFs are available to buy and sell on all the best share dealing platforms. An ETF lets you invest in a whole basket of investments with one cheap purchase, and this automatically prevents you from “putting all your eggs in one basket”. Holding a single ETF doesn’t mean you’re totally diversified, but you can use multiple ETFs to invest in a vast range of assets, markets, countries, and investing themes.
Traditionally, bonds were used as a counterweight to equities held in a portfolio. This is why the traditional 60/40 split, comprising 60% stocks and 40% bonds, was supposed to be the best “set and forget” strategy for long-term diversification.
However, the recent collapse of the bond market has demonstrated that this tactic isn’t foolproof. Bonds can still have a useful place when you’re attempting to diversify your portfolio. But, don’t rest on your laurels and think you simply need to include a few bonds for balance. It’s best to use bonds and bond funds alongside all the other assets and tools at your disposal.
Many won’t argue against commodities playing a helpful role in a diversified portfolio, but the mechanics of investing in them can sometimes be confusing. This is because, after all, you’re attempting to invest in raw materials.
However, there are ways to invest in commodities like gold or timber without getting sucked down the potentially risky path of using derivatives. You can invest in commodity-focused companies (eg mining stocks) individually or by using funds and ETFs. Another tactic is to invest in commodities using an exchange-traded commodity (ETC), which works similarly to an ETF, tracking the live spot price of a commodity.
Individual stocks and shares
If you want a more hands-on approach, using individual equities can be a valuable alternative to ETFs and funds.
Picking out companies involves more research, but it allows you to craft a truly diverse portfolio that suits your investing style and risk tolerance. For example, if you’re looking for regular income – you can focus on dividend-paying stocks. Or, if you have a high tolerance for risk and are aiming for long-term growth, you might choose to explore tech stocks and innovative industry disruptors. There are near limitless options for investing this way. Just remember that it can involve more legwork.
Expert analysis: 3 assets you might not have considered for a diverse portfolio
- REITs. It may not be realistic for you to own an investment property or even afford a home with a mortgage. Well, a real estate investment trust (REIT) allows you to invest in property and commercial real estate with a relatively small sum. This means you can own pieces of property and earn a return without needing to become a landlord or have buckets of money to invest.
- Investment trusts. These managed funds come with higher expense ratios than a passive broad-market ETF. However, investment trusts allow you to get a managed mini-portfolio of investments that can contain anything from space technology to private equity.
- Currency. Along with holding cash for personal use, investing in foreign currency can be worthwhile. For example, in an environment of rising interest rates led by the Federal Reserve, this strengthens the value of the US dollar and makes each dollar more valuable compared to other currencies. Cash tends to devalue over extended periods due to inflation, but depending on what's going on in the global economy, holding foreign currency like US dollars can be a useful diversification tool.
Pros and cons of diversifying your portfolio
- Minimise potential losses and reduce portfolio volatility.
- Exposure to more asset classes can improve long-term performance.
- With ready-made portfolios and ETFs, it’s easy to diversify.
- Holding too many investments can make your portfolio challenging to manage.
- There is a risk of spreading yourself too thinly across assets.
- It can be costly to buy lots of assets if you don’t use a cheap platform.
What else should I consider?
As we mentioned above, if you’re sold on the benefits of diversifying but don’t want to do all the work yourself (or don’t feel confident making all the decisions), you still have options.
The 2 most popular routes are to use a ready-made portfolio (provided by some investment brokerages) or use a robo-advisor that can build and manage a diversified portfolio for a relatively small fee.
How to start balancing your portfolio
If you’re already set up and want to take the next steps to diversify your portfolio, here’s what you can do:
- Consider your goals and risk tolerance. Take a moment to consider your long-term goals and risk appetite. The answer to this may not be the same as when you began investing, and this will help direct your choices.
- Research investments. Take what you’ve learnt and apply it to your personal investing strategy. Build yourself an ideal portfolio on paper containing a diverse selection of investment assets.
- Choose a platform. Not every investment brokerage offers a wide selection of options. Your current account may not include everything you want, so it may be worth looking into moving your portfolio to a new share dealing platform.
- Buy your investments. Once you know how you want to invest and where will let you buy everything, you can construct your portfolio made up of your ideal allocation of assets.
Learning to diversify your portfolio correctly is like looking after your back. It holds everything together, and most of your work should be preventative, to keep it all healthy. With a healthy level of diversification across your portfolio, things should tick over nicely in the background, with less volatility or aches and pains than if you were to concentrate on a single asset.
If you diversify sufficiently from the beginning, you shouldn’t have to do lots of regular tinkering or restructuring. Your portfolio value should have a natural ebb and flow as assets across different markets move in price. There’s no perfect way to diversify your portfolio, but it’s best to be proactive.
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