December 5, 2019
Investing your hard-earned money can be a scary thought, especially since investing is mostly associated with high-risk and a big potential for failure. This is why most people prefer to keep their money in a bank. This, until they start to understand how a simple risk management technique, called portfolio diversification, can help them start earning profits.
If you put all your eggs in the same basket, you risk dropping the basket and breaking all of them, but if you diversify your investments, there are much bigger chances of success, because there is little probability that they will all fail. Below, we will explore the reasons why diversification is so important, how to diversify your portfolio and what are the things you should avoid when doing so.
Why is diversification so important?
To better understand why diversification plays such an important role in developing a successful investment career, you need to explore the benefits a diversified portfolio has. Diversification can mean spreading your money across different asset classes, as well as finding new investment methods and mastering them one at a time. Without further ado, these are the most important reasons why portfolio diversification is crucial for growing your wealth:
The most important reason why investors never put their money towards one single asset is risk management. Imagine the following scenario: you put a few thousands of dollars towards a company’s shares, which seems to be going well, but an unexpected event makes the company’s value drop considerably, or even worse, go bankrupt. This is not impossible at all, as there are multiple stories of businesses that went bankrupt almost overnight.
Developing a successful strategy
One of the key aspects of successful investments is to find a strategy that works for you. It does not have to be the best strategy on the market; it has to be one that you are confident with and that suits your trading and investment style. By spreading your money over various types of investment and trading methods, such as stocks, bonds, CDFs or forex, you get to experiment more, analyze the market and find what suits you.
It is important when you start investing, to constantly be open to opportunities. Stocks and bonds were on everyone’s lips in the past. Now, the focus seems to be going towards cryptocurrencies and forex trading. Did you know that, for example, you can make a profit by investing in Forex via PAMM accounts? Nowadays, expert traders don’t only make money by investing. They do so, by sharing their knowledge with others. Social trading, copy trading, and PAMM (Percentage Allocation Money Management) accounts are just a few examples of how people can make money with the help of expert traders. Such opportunities were only a dream a few years back.
How to properly diversify your portfolio
Understanding the importance of portfolio diversification is one thing, but you also need to find the proper way to do so. While there is no exact recipe for that, given the fact that investors have different money management strategies, there are some guidelines you can follow, to start getting on the right track:
Experiment with fund allocations
In order to find the perfect recipe, one that works for you and not against you, it is important to research your options and focus on those that align best with your investment style. Once you decide on that, you can start experimenting with money. Some options require little investment, while others require more capital and time. By experimenting with different ways to do so, you will be able to find the combination that works best for you.
Keep a balanced portfolio
Always ensure you have a risk-balanced portfolio. Consider adding both moderate and high-risk investments to the mix, with different return rates. This way, when the market fluctuates, you won’t run the risk of losing everything. It is always good to know you have some more secure options available.
Constantly reconsider your options
Portfolio diversification is not a one-time-only job. It is something you need to review and work on constantly. You need to be up to date with the market constantly and make changes to your investments accordingly.
Know when to get out
As important as it is to know when to enter a market, so is knowing when to get out. If you stop making a profit from one of your investment choices, then you should consider dropping it and focusing on something else. This way, you should be able to tell when it’s time to give up on some investments and move on to the next ones.
Diversification mistakes you should avoid
As you can see, portfolio diversification can have many advantages, but it can also make you prone to mistakes. Diversification is only a good thing if you manage to do it right, so be sure to avoid the following mistakes, if you want to make it big:
Don’t bite off more than you can chew
Keep your choices to a limited and manageable number of investments. Diversification is good only when you can successfully manage it. Try on different choices, but stick to those you are able to manage without breaking an arm and a leg.
Don’t forget to keep an eye on the news
Many types of investments are strongly related to political and economic news. Keep yourself informed, to make better decisions on when to enter or exit a trade.
Don’t make impulse decisions
When dealing with so many types of investment, your emotions can take over when you least expect it, and expose you to making mistakes. If one of those investments fail, take a moment to make peace with the situation and avoid taking your anger towards other decisions.
Portfolio diversification is extremely important if you want a real chance to increase your wealth. But in doer to do things right, you need to understand how it actually works. While diversification can bring out many benefits, it can also expose you to a new set of risks. Fortunately, with a bit of research and dedication, you will manage to set yourself up for financial success.