No matter which stocks you choose to invest upon, huge risk is always present. There is no way you can eliminate this risk. However, you can reduce your overall investment risk through an investment technique called portfolio diversification. This is also to help lower the possibility of damaging your portfolio’s performance.
What is portfolio diversification?
Basically, portfolio diversification is a risk management technique that is done by investing your money on multiple types of securities or financial assets. Its main objective is to soften the risks of blowing up your account from bad investments. It can also help ensure your money is invested in different areas of the market that have a chance to outperform. In diversification, it is important to venture on other asset classes like stocks, bonds, and mutual funds. It is more effective if the investments are spread to different industries, and if possible, different countries.
Importance of diversification
Consider a scenario wherein one company has filed bankruptcy. If all of the stocks you own are from that company, you could probably guess how huge its impact would be in your portfolio. However, if you have another company you’ve invested upon, which makes positive returns, then your portfolio is neutrally safe from crashing alongside the other half of your stocks. Now what if you have invested in 2 other companies which are all doing great in the market? You can confidently say that your winning trades will overshadow your losses since ¾ of your investments make positive returns.
It’s also the same if there is a huge economic decline to a whole industry, or in worst cases, to a whole country. If your stocks are diversified to other industries or countries, you’re other stocks are safe from the negative impacts of those losing in the market.
How many stocks should you own?
There is an argue on how many stocks you should own for optimal portfolio diversification. The most acceptable number of stocks is between 15 to 30. These stocks should be spread to other industries, classes, and countries. However, diversification does not prevent losses from your investments. There is still a possibility that the majority of your assets result to a loss. That is why smart choosing of profitable stocks is still the best way to lessen this risk.
Despite doing all these precautionary measures, they don’t guarantee you a good portfolio. No matter how diversified your portfolio is, the risk can never be completely eliminated. It can simply reduce the impact of losses from your investments.
Read more about the importance of following a trading plan.
In order to diversify, make sure that your broker has everything you would need. Trade12 is a leading international online trading brokerage firm that offers investment services on almost all countries. They also offer investments on stocks, foreign currencies, commodities, and other financial securities you could choose to diversify your portfolio. Register an account now with Trade12 and start diversifying!