How to Diversify Your Portfolio the Right Way

You have probably heard the saying, “Do not put all your eggs in one basket.” That is the most common way people explain portfolio diversification. But what does that actually mean for your money? 

Imagine you have $100 to invest. If you put all $100 into just one place, say stocks, you are taking on a lot of risk. If the stock market drops, your entire investment may lose money, as there is nowhere else for your money to fall back on.

Now picture this instead. 

You invest $50 in stocks, $25 in bonds, and keep $25 in cash. Now, you have three baskets instead of one. If the stock market goes through a rough patch, your bonds or cash can help cover up the losses. While you may still see losses, they are likely to be smaller than if all your money were sitting in stocks alone.

That, in a nutshell, is diversification. 

The main goal of portfolio diversification is to reduce risk. It does not guarantee that you will never lose money. Every investment carries some level of risk. But diversification improves your chances of staying steady amid market fluctuations. Diversification spreads your money across different types of investments so that they do not all suffer the same fate at the same time. 

Now that you understand what diversification really is, let’s move on to the practical part – How to diversify your portfolio? This is exactly what you are going to learn in this article. 

How to diversify a portfolio?

There is no single approach to portfolio diversification that works for everyone. Effective diversification requires personalization. You need to understand the strengths and gaps in your portfolio and how they align with your financial goals. Factors such as your risk appetite, investment horizon, and income level all play a key role in your strategy.

But there are a few simple, universal principles that can help almost anyone build a more balanced portfolio. You can review them and adopt what works for you. You can also consider discussing your plan with a financial advisor. At times like these, two heads can be better than one, especially when it comes to your money. 

Let’s move on to portfolio diversification tips that can help you:

1. Assess your risk appetite — This is the foundation of your portfolio diversification strategy

Before you decide where to invest your money, you need to answer one simple question – how much risk are you actually comfortable with?

Your risk appetite is the backbone of your entire portfolio diversification strategy. Yes, your time horizon and goals matter too. But risk tolerance usually comes first. It determines how much you invest in stocks, bonds, cash, and other asset classes.

Risk appetite is about how well you can handle uncertainty. Typically, portfolios can be either of the following:

• Aggressive: These may contain around 80% stocks, and 20% bonds and cash.
• Moderate: These may contain around 60% stocks, and 40% bonds and cash.
• Conservative: These may contain around 40% stocks, and 60% bonds and cash.

An aggressive portfolio may invest heavily in stocks and give you higher growth potential, especially over long periods, but it also comes with bigger ups and downs. A conservative portfolio does the opposite. It focuses more on bonds and cash, which tend to be steadier but usually deliver lower long-term returns. A moderate portfolio balances risk and return, sitting somewhere in between.

Which one should you choose?

That depends on you. If you are younger, have a steady income, and are investing for long-term goals like retirement, you may be able to take on more risk and keep a more aggressive approach. On the other hand, if you are closer to retirement or simply prefer stability, you may want to lean more conservative. Your goals also play a big role. Saving for a house in three years is very different from investing for retirement in twenty. Short-term goals usually call for less risk. Long-term goals give you room to be more adventurous. 

But here’s something many people miss – portfolio diversification is not just about picking one of these models and stopping there.

Even if you are investing aggressively, that does not entail putting everything into stocks. Stocks will make up a larger portion of your portfolio. But you should still leave room for bonds, cash, and possibly other assets. The same goes for conservative investors. Even if stability is your priority, having some exposure to stocks can help protect your money from inflation. 

2. Focus on diversifying within asset classes, not just between them

Most people think diversification is about spreading money across stocks, bonds, and cash. But true portfolio diversification also happens inside each asset class. 

Let’s start with stocks. If you invest in equities, you do not want all your money tied up in one company. If you invest in a single company or sector, your entire portfolio moves with it, adding unnecessary risk. Instead, you can spread your stock investments across different types of companies.

One way to do this is by market capitalization. Large-cap companies tend to be more stable and established. Mid-cap companies often offer a mix of growth and stability. Small-cap companies can deliver strong growth, but they are usually more volatile. Holding a blend of all three helps balance risk and opportunity.

Next, you can look at sectors – technology, healthcare, energy, consumer goods, tourism, beauty, industrials, and more. This way, your portfolio is not overly exposed to the ups and downs of a single industry. You do not have to invest in every sector. But it is advised to browse through and select a few that you are interested in.

You can also diversify by investment style. Growth stocks focus on expansion, whereas value stocks are established companies trading at lower prices. Each performs differently in different market conditions.

Your portfolio also needs geographic diversification. If all your investments are tied to a single country, your portfolio may be riskier. Adding international stocks reduces dependence on a single region. Sometimes global markets may perform better than U.S. markets, which can give your portfolio more balance.

Now let’s talk about bonds. You can mix Treasury bonds, which are generally safer, corporate bonds, which may carry a higher yield but more risk, municipal bonds, which can offer tax advantages, and even Treasury Inflation-Protected Securities (TIPS), which help protect against inflation. 

If real estate is part of your portfolio, you can diversify between residential and commercial properties to gain exposure across offices, apartments, and more. 

3. Consider index funds if you want to keep things simple and still diversify well

If you like the idea of portfolio diversification but do not want to spend your time browsing through companies and sectors, index funds can be a great option. Instead of buying individual stocks one by one, you buy into an entire market or segment of the market at once with an index fund.

Index funds track a benchmark and invest in the same stocks and in the same weightage as the benchmark. For example, an S&P 500 index fund would invest in all the companies included in the S&P 500 index. This would give you exposure to 500 of the largest U.S. companies in a single investment, without you having to manage it all yourself.

Index funds are managed by a fund manager, who assures professional expertise. As a result, this approach is much simpler than building a portfolio yourself. The fund would automatically spread your money across companies, potentially helping reduce risk. 

You also get to save money with index funds. Most index funds have very low management fees because they simply track an index rather than trying to beat the market. Over time, lower fees help you save money, especially compared to what actively managed funds charge.

4. Do not be shy about exploring options outside the usual

If you are open to it and your risk appetite allows, you can also consider alternative investments to further diversify your portfolio. These include assets such as real estate, hedge funds, venture capital, or collectibles.

Alternatives behave differently from traditional investments. Some of these assets may hold their value during an economic downturn. They may also offer some protection against inflation, which is especially useful during periods of rising prices.

But there is an important consideration when using alternative investments for portfolio diversification. Most of these investments are far less liquid than stocks or bonds. You usually can’t sell them quickly or easily. Real estate takes time to exit. Venture capital can take years. Even collectibles can be hard to sell. And even if you find a buyer, you may not always find the right price at the right time. Before you invest, make sure you are comfortable with part of your money being tied up.

So, make sure to do your homework. Alternative investments often come with less transparency than traditional assets. While they are overseen by regulators such as the U.S. Securities and Exchange Commission under frameworks like the Dodd-Frank Act, they still tend to have more complex structures. This makes due diligence essential. You need to understand what you are investing in and how you will eventually exit. It is a good idea to talk it through with a financial advisor. They can help you decide which alternatives, if any, are right for your goals. 

Closing thoughts on portfolio diversification

At the end of the day, personalization is everything in diversification. Consider your goals, timeline, income, and comfort with risk. Also, remember this – diversification is not a one-and-done task.

You may set your target mix. But, over time, your portfolio can drift away. Regular checkups and rebalancing can reset your portfolio. Sometimes this means reducing risk by shifting toward more conservative options, while at other times it may involve adding risk to return to your target allocation.

Finally, continue consulting your financial advisor. If you do not have one, you may explore our financial advisor directory to find one near you.

Frequently Asked Questions (FAQs) about how to diversify investments

1. How to diversify a portfolio at age 25?

At 25, you likely have a long investment horizon, especially for big goals like retirement. So, you may be able to take on more risk and build a more growth-oriented portfolio with a higher stock allocation. But it still makes sense to keep some balance and hold a portion of your money in bonds or cash for shorter-term goals or emergencies.

Your exact mix should depend on your income stability, risk appetite, and personal goals. You can also talk things through with a financial advisor before jumping in.

2. Can portfolio diversification guarantee better returns?

No, diversification can’t guarantee higher returns. Nothing in investing can. Diversification reduces risk by spreading your money across different assets. This, in turn, can potentially lead to better outcomes over time.

3. Does portfolio diversification require expert knowledge?

Not necessarily. If you keep things simple and use index funds, you can build a reasonably diversified portfolio on your own. But if you are adding multiple asset classes, alternative investments, etc., expert guidance can help. You can do it yourself, but having professional input can save you time and stress.

For additional information on retirement planning strategies tailored to your specific financial needs and goals, please visit Dash Investments or email me directly at dash@dashinvestments.com.

About Dash Investments

Dash Investments is privately owned by Jonathan Dash and is an independent investment advisory firm that manages private client accounts for individuals and families across America. As a Registered Investment Advisor (RIA) firm with the SEC, they are fiduciaries who put clients’ interests ahead of everything else.

Dash Investments offers a full range of investment advisory and financial services tailored to each client’s unique needs, providing institutional-caliber money management services based on a solid, proven research approach. Additionally, each client receives comprehensive financial planning to ensure they are moving toward their financial goals.

CEO & Chief Investment Officer Jonathan Dash has been profiled by The Wall Street Journal, Barron’s, and CNBC as a leader in the investment industry with a track record of creating value for his firm’s clients.