One of the most often repeated pieces of advice given to investors is that you should diversify your portfolio. But what does this mean in real terms? Does it mean buying a number of different types of asset (say 40 per cent shares and 60 per cent bonds)? Or does it also mean diversifying within that asset class? Is buying 3 different company’s shares enough or would it take 10 different shares to truly achieve the required diversify? We don’t all have access to sophisticated risk management software such as that produced by Sungard.com/APT but there are many things a novice investor can do.
How can you diversify your investment portfolio in 2014? Try following our suggestions below:
Do as the rich do
What are older, richer, more sophisticated investors doing that makes their strategy so successful? You may not be a millionaire but this doesn’t prevent you from copying the way in which successful investors allocate their assets.
Younger, poorer investors tend to hold three or fewer shares, whereas well-healed investors tend to achieve greater diversity by holding more shares. So whatever percentage of your investment pot is allocated to shares could be spread across a higher number of different companies. If you hold 6 different types of share rather than 3, you have already cut the risk attaching to your share portfolio.
Looking to one of the world’s richest, most successful investors, Warren Buffet holds 90 per cent of his Berkshire Hathaway portfolio in just 15 shares. Whilst you may not have the huge investment capital available to him, you can still select 10 shares rather than relying on 3 to make up this portion of your portfolio.
When you select which shares to buy, you should ensure that they are subject to different risks. You can do this by diversifying the geographic locations of the companies whose shares you buy and also by investing in different industries.
Don’t rely too heavily on home markets
Another trend which has been spotted amongst less-sophisticated investors is their tendency to rely heavily on home markets. When you make investment decisions you need to try and emotionally detach and just look at the facts and figures.
A truly diverse portfolio will include assets held in a number of different geographical locations. This is important to help avoid country risk and foreign exchange risk. Country risk relates to the risk attaching to an asset being held in a particular country. For example, when Greece defaulted on its debts, this devalued all of the investments held in Greece. Foreign exchange risk comes into play whenever you hold an investment abroad. Fluctuations in the exchange rate can mean that you make a loss or that you boost your investment profits, it can work both ways.
Follow the facts rather than the crowd
It may seem like the most basic principle of investing but it bears repeating: the idea is to buy low, sell high. A huge number of investors try to follow the crowd which means that they end up buying an asset when it is very highly priced. If you jump on the bandwagon too late you will end up losing money as the asset price falls and your investment devalues. A good recent example of this was the rush to buy gold. Those who got in early made a profit whereas those who bought gold late were left holding this asset when the prices crashed.
Regularly optimize your portfolio
Your original asset allocation when you set up your portfolio is very important. However, it is just as important to regularly review your assets to make sure they still meet your investment goals. Click here to see the sophisticated risk management software used by professional asset managers. If you are a novice investor managing your own assets then there is a wealth of information available online and in the financial press. Make sure you set aside some time to go through your investments, at least once every 6 months.