How to Diversify Your Portfolio for Massive Growth
Portfolio Diversification – What It Means, How To Do It, & Its Importance
During bull market runs, when everyone is making money, some participants tend to take their eye off the ball and forget about protecting their future interests. A key factor to sustainable and consistent investment gains that separates professional long-term investors from others who tend to lose all of their gains or even more is diversification.
When we look at ways to achieve consistent gains over the long-term, we must always consider different market conditions, and not just the green days. We do not have to go back as far as the 1970s, 1990s or even 2007-2009 to see examples of sudden and steep downfalls, since we have just witnessed sharp declines in 2018 and 2020, and, since 2021, we have been going through uncertain times, where no one can clearly anticipate what may be happening next.
The unprecedented times we live in, where central banks are printing more money than ever, rising inflation, unstable jobs market, and unclear interest rate environment due to inflation and unemployment pulling in different directions, all mean that those who will survive such unknowns are the ones who will have their portfolios organized in a way to both benefit from any future upswings, and, more importantly, minimize the risks of any potential declines.
To achieve this, investments within the portfolio need to take all such factors into consideration. The structure of a well-balanced investment portfolio will always have assets that, all combined together, can weather most storms or, at least, not get as negatively affected as concentrated portfolios would. Portfolios which focus on one asset class, one sector, etc may be setting themselves for failure when (not if) money flows start to move in the opposite direction.
To-Down Diversification Strategy
A tried and tested approach to building a properly diversified portfolio is to take a “top-down” approach. When you try to diversify your portfolio, always think about different positive and negative scenarios of the economic, political, and regulatory environment over both the short- and long-term, and analyze which themes would be best placed to benefit from or minimize the risks of such scenarios. Under each theme, you can then start to look at the different asset classes that you can invest in.
For example, if you decide that logistics is a sector that you want to include in your portfolio, you can then look for asset classes that are within this sector, such as real estate investments related to warehousing, shipping companies, etc, and how you invest in each could also be through debt instruments, equity, structured products, directly or via funds, etc.
Once you have decided on the different themes and asset classes you will be incorporating in your portfolio, you can then move on to the exact investment opportunities to make the most out of each. Once again, you do not want to concentrate the investment opportunities under each asset class, and you want further diversification by choosing several investments within each.
How much is invested in each theme, asset class, or specific investment opportunity remains a topic of debate among investment academics and professionals, and it all depends on your personal risk tolerance. But, as a rule of thumb, you will always want to make sure that if one investment in the portfolio goes to zero, the rest of your portfolio will not be significantly affected. This is why most portfolio diversification approaches consider committing certain maximum percentages of the total to each individual investment. This is actually one of Revolve Capital’s differentiating factors, since we offer our clients tailored portfolios to match their exact profiles; but this is a whole subject to explain in a separate article.
Your portfolio’s diversification strategy does not need to stick to the initial structure you will be deciding on, since you will have to be flexible enough to change when circumstances around you change. Diversification has to make sense in the grand scheme of things, where it fits current environment and circumstances, and not just be diversified randomly for the sake of diversification. Therefore, while you do not want to make regular changes to your portfolio in order to get the most benefits from your investments, you have to do regular evaluations of your big picture (or macro) view to decide on whether the balances of your portfolio themes will remain the same or if you will need to make adjustments.
Moreover, some investments can achieve their full potential, and you will want to consider exiting your position, reducing it, or simply swapping for another. The rebalancing of your portfolio forms a crucial part of ensuring continued proper diversification by eliminating any potential imbalances due to asset value changes.
Diversification Is Key
As you can see from the above, it is not only important to have a diversified portfolio, but it is an absolute necessity in order to achieve consistent long-term gains. Simply, by not putting all your eggs in one basket, your portfolio’s risk diversification should mean that you will not only benefit from rallies during green periods, but you will also be protecting yourself from potential declines by minimizing losses or even making some gains while the markets are struggling.
In conclusion, a concentrated portfolio is a recipe for disaster, especially during uncertain times as any sudden downward changes can mean significant losses, while a properly well diversified portfolio is key to long-term sustainable success for an investor. And, to achieve such diversification, you always need to start with a macro view of the world, and work your way downwards to decide on the different suitable asset classes and proper exact investments you will be putting your money in. You certainly do not want to wake up one day and say, “I should have had more investments in these assets” or “I wish I didn’t concentrate all my investments in these assets.”
Always remember that a successful investment portfolio is not just one that makes you money in a bull market, but also one that protects you during uncertain times. This is a properly thought-out and diversified investment portfolio.