The Importance of Diversification

The Importance of Diversification

August 3, 2020

Ever heard the term, “Don’t put all of your eggs in one basket?”

Well, that’s really all you need to know about diversification. But I will dig into it a bit more just because I’m sure you’re here to learn a bit more than that one sentence!

Diversification is simply an integral part of any portfolio. Why?

• You would never want to lose all of your money in one day because you had it tied to the value of one stock. (Ala Lehman Bros in 2008!)
• You also wouldn’t want to see your purchasing power erode over time because you only held US dollars in cash. This is an example of not diversifying out of cash and into investments!

So what can you do to mitigate those risks? One being single stock risk, and the second being asset class concentration.

Diversifying out Single Stock Risk

There is really only one way to diversify away the risk of owning a single stock… and that to own multiple stocks! Now, how you do that will vary from investor to investor. But one way is to start investing in companies that operate in different industries, are of a different size, and even in a different country.

So for example, if all of your eggs are in Apple stock, you are not diversifying very much by buying Microsoft stock as well. Thats because they are both:

1. Large
2. American
3. Tech companies

The way to diversify away your risk would be to buy something different. Maybe a European consumer staple company like Nestle, or potentially an Asian manufacturer like Toyota.

By holding equity in companies from different geographic locations and different sectors, you will protect yourself from isolated shocks that occur within industries.

Diversifying Away Asset Class Risk

One major asset class that most people expose themselves to is real estate. And they do it on borrowed money, with no positive cashflow. That is, they buy a single family home that they live in and pay a mortgage on.

For many, this real estate investment (their home) is their only investment. That would be characterized as poor diversification. By just adding exposure to stocks, even just one stock, they are broadening their investment pool and moving their eggs out of just that one basket that is their house.

Now, there is an easy way to do this without taking time to research and pick individual stocks: ETFs.

ETFs offer investors a gateway to both wide diversification among equities (you can buy ETFs with exposure to the entire stock market) as well as asset classes (you can buy gold ETFs, Real Estate ETFs, Chinese Equity ETFs, the list goes on and on!)

Read More: What is the difference between the VTI and VOO ETFs

Some great ETFs to keep on your short list when investing and diversifying your portfolio are:

1. VTI (Vanguard Total Stock Market ETF)
2. VWO (Vanguard Emerging Market ETF)
3. AGG (iShares Core U.S. Bond Market ETF)
4. GLD (SPRD Gold Trust ETF)
5. The list is endless! Use ETF.com to search for great funds to invest your money in, or ask us here by emailing or sending a DM on Instagram.

One thing to note before purchasing ETFs is that they are not all created equal. Check out our guide on the risks of investing in them here

I hope that this article was helpful in showing you that diversification is not only important but relatively easy to achieve nowadays with the advent of ETFs that come in a host of different flavors!

Please stay safe and feel free to reach out to us if you have any investing and trading related questions.

MDAS

If you thought this was helpful, terrible, or somewhere in the middle, please leave me feedback in the form of a Direct Message on instagram @MakeDollarsAndSense, or feel free to send me an e-mail/text to the information on my Home Page. I truly appreciate constructive criticism and opposing views, so bring em on!

P.S. New blog posts coming your way every Monday!

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