Portfolio diversification: Tips for new investors
Here are 6 steps every investor should consider when building their investment portfolio.
Most investors are aware of the importance of diversifying investments but often struggle to implement this in their own portfolios.
The aim of having diversified investments is to provide some protection for your portfolio by investing in different types of assets and sectors. Investors face lower risk by using a variety of instruments and it also opens the door to more opportunities.
Here are some simple tips to help you build a strong, diversified portfolio, regardless of your age.
Review your investment plan
Do a review of your monthly budget and savings so that you have a good handle on how much money you have to spare for investments. Remember to take into account any potential medical or other emergencies in your calculations.
Do an assessment of where you would like to invest. It is important to base this on your investment goals because they vary from person to person, for example, whether you're looking for regular income or capital appreciation. This is also a good time to decide on your risk tolerance.
A few easy questions can help in this regard: Is there an industry or sector you would want to associate yourself with such as renewables or companies in the ESG bracket? Are there any popular assets that you would like to dip your toe into? Are there any successful money managers whose strategy you are looking to emulate?
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Look at different asset classes
Investment asset classes include shares, property, bonds, cash and gold, to name a few.
If the lion's share of your investment is in just one or two types of asset classes it is time to research other options that might be available. For example, if 100% of your money was invested in property and the property market suddenly dipped, the value of your portfolio would also fall.
To protect against losses like this, you could diversify by investing in other assets, such as equities, commodities, bonds or currencies.
Consider assets that don't react the same way to adverse events. For example, during an adverse event investors rush to perceived "safe haven" assets such as bonds and gold, while dumping shares whose prices fall. So by investing in different types of assets you reduce the sensitivity of your portfolio to wild movements in the market and keep earning a stable income.
Some investment platforms let you access multiple assets at the same time. For example, on CFD broker IC Markets you can trade stocks, commodities, Bonds, Futures and cryptocurrencies.
A note of warning – with CFDs you're not buying the individual assets. Instead you're speculating on their price movements (up or down). Because you have the option of using leverage (borrowed funds), they're much riskier than regular stock investing and should only be used by experienced investors.
Look at different sectors
Diversifying isn't just about investing in different assets, it also pays to diversify within the asset classes themselves.
For example, if you're investing in stocks, it can be risky to put all your money into just one or two stocks or sectors.
A good rule of thumb is to own shares in at least 10-15 different companies across a variety of industries. You can also select a mix of safe blue chip dividend stocks alongside riskier "growth" stocks and defensive stocks.
Blue chip "income stocks" give stable dividends year after year even though the share price remains more or less stable. Defensive stocks are companies that work in infrastructure and the pharmaceutical space and can be a good addition to your stock portfolio too.
Consider fixed income
Investing in fixed income can reduce your overall portfolio returns but it will also reduce the overall risk and volatility. So it is a good hedging solution against market uncertainty.
Fixed income earning investments include bonds, term deposits, (some) property trusts (called REITs) and other interest-earning cash accounts.
While they typically give you a low return, these options tend to be safer and often come with low fees, which is another bonus.
You can also invest in commodities-focused funds and real estate investment trusts (REITs) which sometimes provide an ongoing fixed income that you can cash in.
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Australia provides only a small share of the world's investment opportunities. Hence, investing some of your wealth in another geography is a great way to help spread your risk of investing in a single market. For example, US stock markets may perform well even when the Australian markets decline.
These days, it is very easy to have exposure in other countries via global-themed ETFs. Consider if this option is good for you.
Keep building your portfolio
Make sure your portfolio is a size that is manageable. You'll want to ensure you always have enough liquid cash on hand in the case of emergencies.
At the same time, keep checking your investments on a regular basis and consider investing smaller amounts over time. This approach can help in cutting down your risk by investing a certain amount of money over a period of time.
Keep up to date with your investments and stay abreast of any changes in overall market conditions. Read news or set up alerts for the companies or sectors you invest in. By doing so, you'll also be able to tell when it's time to cut your losses, sell and move on to your next investment.
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Picking an investment platform
To buy investment products in Australia, you'll need to sign up to an online broker or full-service broker. The right broker for you will depend on how you prefer to invest and what you're investing in.
If you're planning to invest a large sum of money it always pays to get advice from a financial advisor.
If you're looking to buy stocks, you can do so yourself through an online share trading platform. Some brokers let you buy and sell stocks directly. This means you get voting rights and some tax benefits such as dividends.
Your other option is trade stock CFDs, which let you speculate on the price movements of stocks, commodities and other assets. Some investors use these derivative products to offset losses by shorting the market during a downturn. This can essentially protect an existing portfolio without investors needing to sell any stocks (or other).
However, this is a risky strategy for advanced traders only.
Trade with IC Markets
We update our data regularly, but information can change between updates. Confirm details with the provider you're interested in before making a decision.
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