How to Diversify Your Investment Portfolio

Written by Drew ChenelerReviewed by Bryan Junus, CFAUpdated: 25th May 2022
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Working your portfolio up to a well-oiled machine is possible through diversification. It’s not only less risky, but it can also help you generate higher returns in your investment portfolio. 

Whether you are a new or seasoned investor, you’ve come to the right place to learn the tricks of the trade and how you can diversify your portfolio.

You can not only add a diverse group of investment types to your current portfolio but also enjoy the perks of giving your money the best return for the amount of risk you are assuming.

What Is Portfolio Diversification?

The phrase “variety is the spice of life” applies to many things. One thing that you might not apply it to is investing, but it could not be truer.

Diversifying your portfolio is spicing it up with various picks across industries and asset classes. It’s proven to lower your risk and even helps keep your investments from completely fumbling due to crashes in one part of the market or another.

>> More: How to Research Stocks

How to Diversify Your Investment Portfolio: 9 Different Ways

Though you might not have heard of diversification before, it’s not new. This is one of the oldest tricks in modern investing. To start diversifying your portfolio, there are a few things that you can do, which we’ll walk you through below.

#1. Use Target Date Funds

A target-date fund is set to give you a strong return on investment and reduce risk depending on the timeline. Many investors use these to plan out their retirement and set up their funds to give them the best return by that date.

For example, with target-date funds, you can set a date for 20 years from now, allowing your investment to grow steadily over time. If that’s the case and you forget about the funds until your retirement date comes, you could be sitting on a good chunk of change when it’s finally time to retire.

Target Date Funds comprise a mix of investments that changes as retirement nears. To highlight this point, in the early years, target-date funds will invest primarily in stocks but will get more conservative (potentially adding bonds and other securities to the fund) as time goes on. 

#2. Invest in ETFs

Exchange-traded funds (ETFs) are a great option to diversify your portfolio and do so without risking your initial investment.

They come in all shapes and sizes and allow you to invest in various things from one fund. An ETF tracks a broad industry, sector, or commodity.

ETFs are traded on an exchange, they can easily be bought or sold. This can come in handy if you ever need money for a rainy day. ETFs are not made up of one specific stock. Instead, they are a basket of stocks (sometimes hundreds), which adds diversification to your portfolio. 

#3. Consider Mutual Funds

One of the key perks about mutual funds is that you’re generally not going into it alone like exchange-traded funds. There are some solid options out there that professional investors manage. They help you scope out the best opportunities, bundle them up into one security, and collect investments from a large group of individuals.

Actively managed mutual funds are operated by money managers with extensive knowledge of the stock market, knowing exactly where and how to invest the fund’s capital to potentially produce strong returns. Moreover, investing in a mutual fund allows you to diversify your portfolio further. Your capital could be invested across various sectors or in an international market, depending on the fund’s investment strategy. These are just two examples, but the point is that mutual funds are diversified products. 

#4. Bonds

If you feel that you have your eye on a good company, one thing that you could invest in are bonds.

Companies and government institutions use bond investments to get their ideas off the ground. You could become a part of that, adding in your investment and earning a return in the form of interest payments. 

It’s always good to have bond(s) exposure in your portfolio, giving you a solid way to benefit from the long-term in what’s considered to be a lower-risk investment. Generally, bonds are less volatile than stocks. Investing solely in stocks is a risky proposition for most investors. Adding bonds to your portfolio and other asset classes helps reduce risk. 

#5. Individual Stocks

With all of the diversification options, individual stocks tend to get pushed aside. However, when you’re looking to diversify your portfolio, you should save some space for stocks, especially those with promising returns. If you want to add individual stocks to your portfolio, consider stocks from different industries that have low correlations to each other. This will help reduce risk in your current portfolio. 

The one thing that you have to watch out for when choosing to add some individual stocks to your portfolio is not adding too many, make sure you don’t go overboard. You want to make sure your portfolio is balanced, accommodates your risk tolerance, and helps you achieve your financial goals. 

#6. Index Funds

Index funds fluctuate depending on a market index. An index may have stocks and bonds, mirroring whatever the tracked index shows. Index funds can come in the form of ETFs or mutual funds. 

Index funds usually have a manager overlooking the index. This helps ensures it closely mirrors a particular index.

Some of the largest indexes on the stock market include the S&P 500, Dow Jones Industrial Average, and Nasdaq.

If you’re already invested in a few things throughout the market, adding an index fund could be just the thing you need to diversify your portfolio, while simultaneously decreasing your risk and increasing your potential return.

#7. Real Estate Holdings

Real estate is another asset class you can invest in to diversify your portfolio further. Instead of buying a home or property, you can diversify your portfolio and reap the benefits of a real estate investment trust (REIT).

When you invest in a REIT, you’re becoming part of a team of investors that invests in various real estate properties. For example, this could mean investing in single-family homes, condominiums, or apartments. 

An investment like this not only lowers risk, but it also is the perfect complement to some of the options we’ve listed above. Investors favor adding real estate to their portfolios because it has a low correlation to other asset classes like stocks, ETFs, mutual funds, and bonds. 

#8. Sector Funds

You may see many sector funds listed as mutual funds or EFTs. Whatever the case, the main difference between them is that they look at only particular industries. Some examples include tech, telecommunications, consumer staples, etc.

Sector funds pinpoint only one part of the market, which has advantages and disadvantages. The point of diversifying is continuing to make money no matter what the market decides to do, so add a sector fund or two to hone in and invest in one specific industry.

#9. International Stocks

One of the best things about investing in today’s day and age is that you don’t have to keep it local. As a matter of fact, you can branch out and cross the high seas, investing in international stocks as well.

Thanks to the internet and the long list of online investing tools, investing in international stocks is not as uncommon as it used to be. If you’re thinking about going this route, consider international exchange-traded funds and mutual funds as ways to add a bit of simplicity to your foreign investing.

The categories covered above are not all-inclusive. These are just a select few asset classes you should consider if you want to diversify your portfolio as an investor. 

Tips for Diversifying Your Portfolio

Now that you know a few ways to start diversifying your portfolio, we thought we’d leave you with a few tips. Consider these tips first before you take off and start adding new things to your portfolio.

Follow the Buy-and-Hold Strategy

While making money day trading seems to be the trendy thing to do, try and refrain. Most people who day trade are worse off than long-term investors. There is a negative correlation between the number of transactions people make and their returns. Start thinking of some long-term investments and turning away for a while.

>> More: What Is the Buy and Hold Investing Strategy?

Use Asset Allocation

One of the main reasons diversification tends to come with much less risk is that your money is spread out over different investments.

Mixing up high-risk and low-risk investments is a great way to diversify your portfolio and keep things working like a well-oiled machine. While it will usually all work itself out, you should still take the time to strategize how to divide your assets. 

You can always add or subtract assets over time, seeing how your choices play out before sticking with them for the long run.

Rebalance Your Portfolio Regularly

One way you can keep a close watch on what your money is up to when you have multiple investments is to stop, take a look, and rebalance it accordingly. While you can probably assess your portfolio on your own, you can also seek a professional to look at your portfolio and see how it’s playing out. Dedicated financial advisors will help you set achievable financial goals and will provide sage advice as you construct your portfolio. 

Example of Portfolio Diversification

We’ll leave you with an example of what diversifying your portfolio might look like to drill things in.

Let’s say you have three things in mind, domestic stocks, bonds, and foreign markets. You could divide it into 50% domestic stocks, 30% bonds, and 20% foreign stocks.

In those percentages, maybe you have three or four that take up a total of 50% of your entire investment amount, or you could choose one stock and invest in that. Remember, putting all of your money into one stock isn’t the best thing to do. Instead, it’s better to diversify your portfolio across different asset classes. 

What Is Good Portfolio Diversity?

Well, that depends. It depends on how good you are at selecting stocks and the amount you have to invest. Try and shoot for at least three different types of investments when you’re starting out, adding to your portfolio, and branching out further over time. A healthy mix of stocks, mutual funds, ETFs, and bonds will lead to a diversified portfolio that reduces your risk and increases your chances of success. 

Is it Hard to Diversify an Investment Portfolio?

At first, it might be. This is especially true if you don’t have prior knowledge about financial markets, asset classes, and investing. Though you might seem lost at first, remember you can ask a professional, and learn as you go.

Why Should Investors Diversify their Portfolio?

One of the key reasons all investors should diversify their portfolios is to reduce risk and increase portfolio returns. By only investing in one area of the market, your portfolio is at a higher risk of plummeting. Spreading out your assets helps reduce your risk and means you don’t have to rely on just one area of the market. Your portfolio will be able to weather the turbulence of the financial markets. 

Bottom Line: How to Diversify Your Portfolio

The main goal of investing is to grow your initial capital. By setting goals now, you can set your portfolio up to make you money, no matter what happens in the market. Diversifying your portfolio will help you reach your financial goals and reduces risk. 

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Drew Cheneler
Drew Cheneler

Drew is our Co-Founder and is a recognized Credit, Small Business, and Personal Finance Expert. He has been featured in CNBC, Fox Business News Section, The Huffington Post, Business.com, Moneyunder30, US Chamber of Commerce, and more. He is known for breaking down complex personal finance topics into action-oriented advice, so you can make the most of your hard-earned money. Drew attended the U.S. Coast Guard Academy where he majored in Business Management with a focus on Information Systems.