There are many reasons why, as a trader, you should diversify your portfolio. Investment always comes with a certain level of risk. As an investor or trader, you’re constantly looking for ways to mitigate that risk. The best way to do this is to have a variety of different assets and investments.
Here, we’ll discuss five of the reasons you should diversify and how it can benefit your trading career in the long run.
What is diversification? Just to make sure we’re clear on the definition: diversification is a means of reducing risk by allocating your investments between different industries, markets, and categories. The idea behind diversification is to maximize your returns by having a variety of different investments.
- Reduced risk. Undoubtedly you’ve heard the adage “don’t put all your eggs in one basket”. When it comes down to it, this is one of the key reasons you should diversify. Basically, if you’re investing all of your money in one area, your risk level is far higher. For example, say you’re only investing in penny stocks. While tools like StocksToTrade can help mitigate risk by helping you filter stock choices and research, there is still an inherent level of risk. It’s alarmingly easy to blow up your account; all it takes is a poorly executed attempt at short selling. By diversifying, you can spread your wealth around a little bit, so that you’re not risking everything.
Of course, it’s important to clarify that diversification cannot completely remove risk. Investing will always come with some level of inherent risk. It’s a method of mitigating risk, not destroying it.
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- Take advantage of different markets. Diversification allows you to explore different markets. For instance, rather than just investing in the OTC or the NYSE, you might explore some of the Asian markets. Investing globally can be a great way to diversify your investments, because different areas of the world may be experiencing different growth than the domestic market. Many investors might choose to expand with Asian investments, for example, because these nations are still considered powerhouses of exporting; as the gross domestic product rises, so do the opportunities for investment and return.
- Weather market storms. Sometimes, a market event can affect a particular industry, which can negatively affect your entire portfolio (take, for example, the dotcom bubble or the real estate collapse). Diversifying allows you to invest in a variety of industries, company types, and even different sorts of assets. By having a variety of assets, you are better prepared to weather market storms. If there is a cryptocurrency crash, for instance, other investments can help you survive the storm. This helps you protect your wealth in the long run. Also See: Cryptocurrency Mining 101
- Alternative assets. Diversification doesn’t just have to mean that you’re investing in the stock market. It could mean that you explore different types of assets, too. For instance, you might invest in the following ways:
- Real estate: Real estate returns have a somewhat low correlation to stock investments. This makes them a great way to diversify your portfolio.
- Peer to peer lending: This is a lending system which doesn’t involve the traditional financial channels. With peer to peer lending, you are in essence the bank, lending money to another person with an agreement that they will pay you back with interest.
- Invest in a business. Entrepreneurs need startup cash. Could you be the silent investor who makes a difference? By investing in this way, you provide financing but are not involved in the day to day operations of the company. However, you will be entitled to a portion of ownership of the company and will benefit from the income it receives.
- Gain a better understanding of the market. Moreover, diversifying your investment portfolio will make you a more well-rounded investor and trader. By exposing yourself to different markets and different investment types, you’ll gain a more inherent understanding of the economy and what makes money move. By continuing to educate yourself in these ways, you’ll expand your knowledge base. Knowledge is power when it comes to investing. The more you know, the more investment ideas you’ll be able to generate. One thing is certain: the market and the business landscape are both ever-changing. By diversifying, you’ll be better able to stay mentally on top of it, thus remaining more nimble as an investor.
Conclusion: As you can see, there are many reasons why you should diversify. As an investor, diversification is an important aspect of maintaining a healthy and well-balanced portfolio.
How do you keep your portfolio diverse?