Jasmine Birtles
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How to Build a Diverse Investment Portfolio in 5 Steps
Ruby Layram
19th Nov 2024
Diversification is a key element that should be considered in every investing strategy. It is an age-old process that helps you to reduce the risks of investing by spreading your investments across different markets and asset classes.
We talk a lot about diversification on MoneyMagpie – and for good reason! To help you better understand what it means to diversify your portfolio and how to build a diverse investment portfolio, we have put together a step-by-step guide to investment portfolio diversification.
In this guide, I’ll walk you through everything you need to know about diversifying your investment portfolio.
Whether you’re starting out with a small monthly contribution or looking to overhaul your current investments, this step-by-step guide is packed with tips, examples, and friendly advice to help you along the way.
What is Portfolio Diversification in Investing?
Diversification is a fancy term that refers to the process of spreading your investments across different assets to reduce risk.
Think of it like a buffet. If you only pile your plate with one dish and it turns out to be a dud, you’re left hungry. But if you sample a variety, chances are you’ll leave satisfied even if a couple of items weren’t your favourite (sorry if you’re hungry now!).
In investing, this means avoiding the temptation to put all your money into a single stock, industry, or asset class. Instead, you vary your portfolio with stocks, bonds, property, gold, and even alternative investments like artwork or designer handbags. The goal is to minimise losses if one area takes a hit.
A diverse portfolio covers multiple areas to increase the chances of seeing returns and reduce the impact of losses.
What Are the Advantages of Diversification?
There is a reason that diversification is such as buzz word in the investing space. It comes with a heap of benefits! Here are a few key advantages that come with diversifying your portfolio.
- Risk reduction: If one of your investments takes a dive, others can help cushion the blow. For example, when stock markets wobble, gold prices often climb. So by investing in both asset classes, you mitigate losses.
- Steady returns: By spreading your investments, you’re less likely to experience dramatic ups and downs. Your portfolio becomes more balanced, which is ideal for long-term investors.
- Opportunities for growth: Different assets perform well under different conditions. Diversification means you’re always positioned to benefit from shifting market trends. For example, Bitcoin tends to do well when interest rates dip and Gold tends to strengthen during times of economic uncertainty.
- Peace of mind: Knowing you’re not overly reliant on one investment can help you worry less about the performance of a single stock or area of the market. This will allow you to step away from your computer screen and let your investments grow in the background.
Investment Portfolio Diversification Examples
As we’ve already mentioned, there are several ways that you can diversify. In fact, the true pros can probably think of dozens of different ways to build a diverse portfolio.
But to keep things simple, here are 3 popular options to consider.
Diversifying across economies
‘Economy’ refers to a system of production and trading in a specific region or country. The term is often used in the news and in financial reports to refer to how money, goods, and services move between people, businesses, and the government in a society.
Imagine this: you’ve invested everything in UK companies. What happens if the British economy has a rough patch? Your portfolio takes a hit.
Diversifying across economies—like adding US, European, or emerging markets—can help mitigate that risk.
For example, you could diversify your portfolio across different economies by investing in:
- UK equities for stability.
- US tech stocks for growth potential.
- Asian markets for exposure to rapidly growing economies.
Check out these 3 Indian ETFs to watch for inspiration.
Diversifying across asset classes
Asset classes are the different types of investments, such as stocks, bonds, and property. Each reacts differently to market conditions. Stocks might provide returns in a booming economy, but bonds tend to hold steady during downturns.
There are quite a few different asset classes to consider. So I recommend starting with 2 or 3 that align with your long-term investment strategy.
Here are a few different types of asset that you could consider.
- Stocks: Higher risk but higher reward potential.
- Bonds: Lower risk, steady income.
- Property: A tangible asset with long-term growth potential.
- Commodities: Gold, oil, or even agricultural products to hedge against inflation.
- Cryptocurrencies: Bitcoin, Ethereum or altcoins that support decentralized financial systems. These come with higher risk but can provide substantial returns in a short space of time.
- Alternative Investments: Think art, or collectibles for those who like a sprinkle of adventure.
A good way to diversify across asset classes is to mix high-risk, high-reward assets with ‘safe havens’. For example, you could invest in Gold and Bitcoin.
Diversifying across industries
If you choose to invest in stocks, spreading your investments across industries is vital. For instance, if you only invest in tech and the sector faces a slowdown, your portfolio takes the brunt.
To reduce this risk, diversify with sectors like healthcare, energy, consumer goods, and finance.
Much like asset classes, different industries come with different levels of risk and reward. For example, growth stocks in the tech industry have the potential to provide staggering returns but can be very volatile.
Whereas, banking stocks, such as Lloyds or Nationwide, provide a bit more stability but may not see huge growth.
How to Build a Diverse Investing Portfolio
Building a diversified portfolio isn’t as daunting as it sounds. Here is a step-by-step guide to get you started.
Step 1: Understand your budget and risk tolerance
Before diving in, know how much you can afford to invest and what level of risk you’re comfortable with.
If you’re nervous about losses, you’ll want a more conservative portfolio with bonds and stable stocks. If you’re up for a bit of risk, growth stocks and cryptocurrencies might suit you better.
Step 2: Decide How You Want to Diversify
Keeping your risk tolerance in mind, the next step is to determine how you want to diversify.
Of course, over time, the goal is to diversify across all areas. However, this takes a lot of time build up!
At first, pick just one diversification strategy that aligns with your risk tolerance and long-term goals.
Your risk tolerance depends on factors like your age, income, and financial goals. A young investor might take on more risk, knowing they have time to recover losses, while someone nearing retirement may prioritise stability.
Your goals are more about what you’re investing for. Are you saving for a house? Building a retirement nest egg? Funding a dream holiday?
Your goals will shape your investment strategy. Short-term goals might favour safer assets, while long-term goals provide room for a bit more volatility.
In general, diversifying by investing in stocks that cover different industries is the most high-risk option. This is because all stocks come with a bit of volatility compared to assets such as Gold and bonds.
Step 3: Consider funds and managed portfolios
One of the easiest ways to create a diverse portfolio is to have someone else do it for you!
Managed portfolios, such as mutual funds or exchange-traded funds (ETFs), offer instant diversification, without you needing to handpick different assets.
For example:
- Index Funds: Track a specific market index, like the FTSE 100. This allows you to invest in a basket of stocks that trade in the same market.
- Sector Funds: Focus on specific industries, such as tech or healthcare.
- Balanced Funds: Combine stocks and bonds for a mixed approach.
Platforms like eToro also provide Smart Portfolios, which are ready-made portfolios catered to different investment goals. You could also consider investing in a managed Stocks and Shares ISA – in this case, your money will be invested on your behalf based on your risk tolerance and goals.
Step 4: Do your research
Knowledge is power, especially in investing. Before committing, make sure you’ve done your homework.
If you decide to build your portfolio yourself, it’s important to take time assessing different options and conducting thorough stock market research.
What to look for when building a diverse investment portfolio
- Performance history: How has the asset or fund performed over time?
- Fees: Watch out for hidden charges that eat into your returns.
- Reputation: Stick with trusted companies or platforms.
- Liquidity: Can you easily sell the investment if needed?
Read our helpful guide on how to conduct stock market research to learn more about the research process. We also have a brilliant guide on how to read earnings reports for those of you who want to get into the nitty gritty.
Step 5: Create an investment account that supports your Desired assets
Finally, make sure you’re set up on an investing platform that offers the range of assets you want to invest in. Whether it’s a brokerage account for stocks, a property investment platform, or a gold-buying service, choose one that aligns with your goals.
Check out our list of the best investment platforms for UK investors.
What is the Best Way to Diversify Your Portfolio?
The truth is, there’s no one-size-fits-all answer. The best approach depends on your unique circumstances, goals, and preferences. However, a well-diversified portfolio generally includes a mix of:
- Stocks and bonds.
- Domestic and international assets.
- Tangible and intangible investments.
- High-risk and low-risk options.
Regularly reviewing and rebalancing your portfolio is key. Over time, some investments will outperform others, which might skew your balance. Adjust as needed to keep everything aligned with your strategy.
Diversifying your portfolio might sound like a lot of work, but trust me, it’s worth it. The peace of mind that comes from knowing your investments are spread across a range of assets, industries, and markets is priceless.
And remember, you don’t have to do it all at once. Start small, build steadily, and watch your investments grow over time.
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Disclaimer: MoneyMagpie is not a licensed financial advisor and therefore information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This should not be considered as financial advice. Anyone thinking of investing should conduct their own due diligence. When investing your capital is at risk.
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