The Guide to Diversification| North Loop Official Blog
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26 Nov 2020

The Guide to Diversification

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Introduction -

No form of advice, investing idea or tip can replace a real investment strategy created keeping in mind your personal financial goals and risk profile. Experts always recommend creating a plan that helps you achieve your goals no matter what surprises the market brings up. One of the first steps to do so is to form a diversified portfolio with a mix of stocks, bonds and other investments and to maintain a strategic investment allocation to achieve long-term investment success.

A regular reviewing of your investments also plays a critical role in creating a well-diversified portfolio that aligns with your financial preferences and priorities. According to many experts, at the very least, an asset allocation mix should get checked once a year. That can help you assess if your portfolio is in tune with the significant changes in your financial circumstances if any. It can also help you determine if you need to rebalance your investment allocation or reconsider some of your specific investments.

Why diversify and how to diversify portfolio?

Diversification in investing is crucial for improving your returns for whatever level of risk that you choose to target. It may not boost the performance of your investments or guarantee against losses, but it does have the potential to reduce the overall risks of your portfolio and increase the returns.

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How to diversify portfolio?

A diversified investment portfolio can get built by adding investments that do not usually move in the same direction. That means even if one portion of your portfolio declines, the rest increases or does not fall as much. Another aspect that you can keep in mind when creating a well-diversified investment portfolio is to try and stay diversified within each type of investment. In other words, you can choose to avoid over-concentration in a single investment.

For example, many professionals believe that one stock should not make up more than 5% of a stock portfolio. This kind of stock portfolio example gets advocated by many experts who suggest that it is smart to diversify across stocks by market capitalization, sectors and geography.

Since not all sector or regions prosper at the same time or the same degree, it can effectively reduce your portfolio risk by spreading your assets across different parts of the stock market. Another stock portfolio example for diversification would be a mix of investment styles such as growth and value.

Some other points on how to create an investment portfolio that is well-diversified -

When focussing on how to create an investment portfolio that is well-diversified, there are several other factors that you need to consider. Some of these include looking at your asset mix such as stocks, bonds, short-term investments and making sure that they get aligned to your investment time frame, financial needs and comfort with volatility.

You can try different levels of stock diversification, and assess various sample asset mixes that include various amounts of stock, bonds and other investments to understand the different levels of risk and return potential.

To diversify stocks, you can target date-funds, invest in a mix of mutual funds or ETFs, customize with individual stocks and bonds and even opt for geographic market diversification. Such a market diversification involves investing abroad and can help you to compensate for the volatility of a single economic region. In the long run, it can reduce your risk relative to less-diversified portfolios. Some experts claim that adding a little complexity in stock diversification helps in creating a well-rounded portfolio.

Moreover, along with creating strategies to diversify stocks and your portfolio, it is equally necessary to carry on periodic checks and rebalancing efforts. Diversification in investing involves not only settling on a target mix but also tracking it periodically and rebalancing it if necessary.

The goal should be to reset your asset mix to keep bringing it back to an appropriate risk level for you. That can mean reducing risk by increasing the portion of a portfolio in conservative options or even adding more risk to get back to your target mix.

Summarising the above discussion -

3 step approach for diversification -

Create a tailored investment plan
Invest at an appropriate level of risk
Manage and review your plan

For the third step, the three key points that experts feel you should remember -

Monitor - Evaluate your investments regularly to check changes in strategy, relative performance and risk.
Rebalance - Consider rebalancing if you feel that any part of your asset mix has moved away from your target by more than ten percentage points.
Refresh - Revisit your plan annually or when your financial goals change to ensure it remains relevant.

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This publication is provided for general information purposes only and is not intended to cover every aspect of the topics with which it deals. It is not intended be advice. You must obtain professional advice before taking, or refraining from, any action on the basis of the content in this publication. The information in this publication does not constitute legal, tax, investment or other professional advice from North Loop or its affiliates. We make no representations, warranties or guarantees, whether express or implied, that the content in the publication is accurate, complete or up to date. All opinions expressed do not reflect the views of North Loop nor are endorsed by North Loop.