There is nothing more frightening for investors than the thought of losing their hard-earned money. Investing is already considered a high-risk venture and the potential for failure is always hanging over investors’ heads. However, this changes when they start to uncover a simple risk-management technique called portfolio diversification.
Keeping your eggs in the same basket puts the all at risk of breaking if one were to drop that basket, but diversifying your portfolio maximizes your chances of making profits and reduces the chance of complete failure.
Learning how to trade one asset is challenging enough, especially for beginner investors. This is why most of them are afraid of diversification. But this is your best chance at ensuring bigger wins and developing your investment skills.
Below, we will attempt to explain to you why portfolio diversification is so important and what you should and shouldn’t do when it comes to exploring your options.
Why does portfolio diversification matter?
The only way to understand why portfolio diversification is paramount for a successful investment is by taking a look at the multiple benefits it brings. Keep in mind that portfolio diversification may mean a lot of things. It could be that you are a forex investor and wish to trade new currency pairs, or that you are trying new assets altogether. It could also mean you are keen to enter a new market or explore the opportunities inside the market you are already accustomed with.
There are many reasons portfolio diversification can be so important for growing your wealth, but the following are the most important ones:
- Finding new financial opportunities
A good investor is always open to experimenting with new opportunities. The stock market was everyone’s favorite for a while, but is now losing a lot of terrain in front of markets such as forex and crypto. Adapting to these changes and seeing them as potential investment options is paramount if you want to become a successful investor.
- Diminishing potential risks
One of the main reasons for portfolio diversification is to diminish risks. Putting your money towards one single asset only works if you are extremely experienced in trading that particular asset. And even then, risks are still constantly present. Unexpected events are happening at any time, and they can affect the movement of an asset in various ways. Companies can go bankrupt in the blink of an eye, and this can tremendously harm investors’ finances.
- Improving your trading skills
By experimenting with various trading assets and strategies, you get to learn more about financial markets and choose your main investment activities based on knowledge, not chance. Learning about key differences between certain markets or trading techniques, makes you become a better trader and use that knowledge to your advantage. Beginner traders, for example, rarely know the key differences between futures and options, but an experienced trader will have no problem separating the two.
What can I do to diversify my portfolio?
Now that you know a few reasons why portfolio diversification is so important; how can you start leveraging that? What is the proper way to diversify your investments and grow your wealth?
Well, trading is a very subjective experience and what works for an investor may be the doom for a different one. This happens because each investor develops a unique combination of risk tolerance, appetite for money, trading strategy and ultimate financial goals.
However, there are some things you can do to get started with portfolio diversification:
- Keep a balanced portfolio
Developing a risk-balanced portfolio take some time, but is not impossible. The key to having a balanced portfolio is making sure you include both high-risk and moderate risk investments, each having different return rates. This allows you to make money both on the long and short-term. At the same time, if there are fluctuations in the market, which will happen at times, you only risk losing a fraction of your account.
- Always be open to change
What many investors get wrong is the fact that portfolio diversification is not a one-time job. The markets change rapidly, and you need to be ready to adapt. If a type of investment is not profitable anymore, don’t hesitate to pour your funds into something different. Review your portfolio constantly and make the required changes to keep it as profitable as it can be.
- Try different fund allocation rates
As an investor, you will be the only one to know what type of assets help you achieve your financial goals faster. But besides assets diversification, you also need to consider how you will be distributing your money. Some trading options will require very little funding and can make slow, steady profits, while others may be riskier or require more funds. It is up to you which one will be present more in the portfolio.
- Always know when to step out of the game
Knowing the exact moment when to enter a market is very important, but knowing when to close a transaction or when to entirely give up on an asset is even more crucial. If you stop making profits from one of your investment choices, it may be time to give it up and reconsider your options. Don’t let one bad investment drag your entire account down.
Make sure not to make these rookie mistakes
There are many things that can go wrong with portfolio diversification, especially when you are experimenting with a new asset. Make sure you don’t fall into one of the following traps, which can cost you big money:
Never make impulse decisions! Control your emotions and don’t let them dictate your actions, or they can leave you prone to mistakes.
Keep yourself informed! Read reliable news, study the market and make sure to stay update with emerging assets and new trading techniques.
Know your limits! Make sure your portfolio is kept to a manageable number of investments, otherwise you won’t have the time or resources to keep up with it.