Diversification is spreading your investments across different assets to reduce risk. It is one of the most important principles in investing. Here is how to do it right.
Why Diversify?
Diversification reduces the impact of any single investment going wrong:
- If one stock drops, others may hold steady or rise
- Different asset classes perform well in different conditions
- Reduces portfolio volatility
- Protects against company-specific risk
Key principle: Do not put all your eggs in one basket. The goal is to have investments that do not all move together.
Ways to Diversify
1. Across Asset Classes
- Stocks (growth)
- Bonds (stability)
- Real estate (income)
- Cash (safety)
- Commodities (inflation hedge)
2. Across Sectors
- Technology
- Healthcare
- Financials
- Consumer goods
- Energy
- Utilities
3. Across Geography
- US stocks
- International developed markets
- Emerging markets
4. Across Company Size
- Large-cap (stable)
- Mid-cap (growth potential)
- Small-cap (higher risk/reward)
How Much Diversification?
There is a balance - too little is risky, too much dilutes returns:
- Under-diversified: 1-5 stocks is too concentrated
- Well-diversified: 20-30 stocks captures most benefits
- Over-diversified: 100+ holdings may just mirror an index
Easy Ways to Diversify
- Index funds: One fund gives exposure to hundreds of stocks
- ETFs: Trade like stocks but hold many assets
- Target-date funds: Automatically rebalance based on your timeline
Diversification Mistakes
- Thinking 10 tech stocks is diversified (it is not)
- Over-weighting your employer's stock
- Ignoring correlation between holdings
- Never rebalancing
Rebalancing
Over time, winners grow and change your allocation. Periodically rebalance:
- Sell some winners, buy some laggards
- Return to your target allocation
- Rebalance annually or when allocation drifts 5%+
Track Your Portfolio Allocation
Pro Trader Dashboard shows your sector and asset allocation at a glance.
Summary
Diversification reduces risk by spreading investments across different assets, sectors, and geographies. Use index funds or ETFs for easy diversification. Avoid over-concentration in any single stock or sector. Rebalance periodically to maintain your target allocation.
Learn more: dollar cost averaging and dividend vs growth stocks.