Diversification is all about building your portfolio with different types of investments. For example, instead of only investing in stocks from big companies, you could also get stocks from smaller companies in different industries. And then, you could get a few bonds and invest some money in real estate.
So, why is it important to diversify investments, and how can you do it? Let’s start by looking at the five benefits of diversification.
1. You decrease the risks of losing money
When you invest all your money in the same place, you put all your eggs in the same basket. And if you drop your basket, all your eggs risk breaking.
Diversifying your investments is important because it makes it less likely that you will lose all the money you have invested. If the stock market crashes or only a few of your stocks fall, the money you have invested elsewhere will be safe. The assets you still have will help offset your losses. For instance, investing in mortgages is an excellent way to mitigate the risks of your other investments.
Of course, diversification can’t eliminate the risks of losing money. But you decrease those risks when your portfolio involves assets that don’t always move in the same direction.
2. You have more chances of getting a big return on your investments
You invest money to get a big return on your investments, right? Diversifying your investments gives you more chances of achieving this goal.
Predicting which investments will perform well over time and which will perform poorly can be difficult. A diverse portfolio increases your chances of seeing at least some of your investments do well.
3. A diverse portfolio is less volatile
A diverse portfolio should feature investments with different risk profiles. While some perform poorly, others will do very well and keep rising in value, so you won’t have to worry about incurring important losses.
Your diverse portfolio will help you remain confident in your investments whenever the market has ups and downs.
Diversification is important because it helps limit volatility and also because it helps you preserve your peace of mind during uncertain times. If you have hesitated about investing your money because you were afraid of losing it, ask a financial advisor to help you build a diversified portfolio.
4. It can help you manage the risks that come with inflation
Diversification will also help you manage the risks that come with inflation. As the prices of goods and services increase because of inflation, the purchasing power of investors decreases. This is why adding commodities to your portfolio makes sense.
Investing in commodities such as grain, coffee, oil, natural gas, and gold will ensure your portfolio performs well during inflation.
Investing in real estate is also a good idea to reduce risks, as real estate prices usually move with inflation. Even when people have difficulty affording vacations or luxury purchases, they still need a place to live.
5. It can help you reach your long-term financial goals
You probably want to invest money so you can reach long-term financial goals. Another benefit of diversifying your investments is that a diverse portfolio will be more likely to help you reach your goals than a portfolio consisting of only one type of investment.
You want to take risks with your investments, but not too many risks. With a diversified portfolio, you can take the right risks to generate wealth without losing it all.
And when you decrease the risks of incurring losses and increase the chances of getting a big return on your investments, it’s only a matter of time before you make your plans a reality.
How can I diversify my investments?
Now that you know why it’s important to diversify your investments, you need to know how you can do it. A financial advisor could help you, but you should also ask yourself a few questions to get started.
Ask yourself how much money you can invest and what your goals are. Then, be honest about the level of risk you are comfortable taking.
Next, decide which types of investments you are interested in. For example, you could get stocks and bonds from different companies in different industries, invest in real estate, and get a guaranteed investment certificate.
Is it possible to diversify too much?
Of course, diversification is not perfect. If you invest small amounts of money in too many places, it could become impossible for you to achieve your financial goals in the long term.
So, you need to diversify but do it in a way that makes sense. Imagine you have a dozen of eggs that you need to bring home. It makes more sense to place them in 3 or 4 different baskets than to have one basket for each egg.
