This is Part 2 of a mini-series on investing. Check out Part 1 here!
Today, we are going to answer the question: “What does a diversified portfolio look like? Everyone says that you should have a diversified portfolio, but most people do it wrong. Here’s what you need to know.
How diversification works and why it matters
- Diversifying reduces your exposure to any one asset class or sector.
- What performs well changes year after year. By owning a broad range of companies, industries and asset classes, you’re sure to capture the best performers and to reduce loss when performance suffers.
- Owning uncorrelated assets: the reason you want broad exposure to all areas of the market that don’t necessarily move in tandem is you can reduce volatility without sacrificing return.
- By reducing volatility – you actually increase your ability to compound returns.
How do you know if you’re diversified or not?
- Research has shown that you can create a diversified portfolio with as little as 20-30 stocks.
- The easiest way for the vast majority of people to get diversification and do as well as the market is by owning a mutual fund or ETF.
- Remember, you can’t just choose 10 mutual funds and call it diversification. It all depends on how that fund is being managed and the make-up of those funds. There could be overlap and unnecessary positions.
- Questions to ask yourself
- Do you own just a couple stocks? If so, you’re probably taking a lot more risk that you should be
- Am I exposed to all industries or am I making bets in only certain areas? If so, I’m probably missing out when other industries do better or when mine is out of favor?
- Run your portfolio through analysis tool – I’ll link to the one I use in the show notes (see below)
“Diversification is about accepting good enough while missing out on extraordinary so you can avoid terrible.” – Ben Carlson
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