If you’re investing in a broad selection of financial instruments, you may think that your portfolio is quite diverse. After all, you have a bit of everything in there.
Unfortunately, just having more items in your portfolio doesn’t mean you’ve achieved diversification. It just means you have more things in there.
Diversification comes from correlation. The less correlated your assets, the more diversified you are. That’s what really counts.
The following post explores some of the ways you might not be diversifying properly and what you can do about it.
Overweighting In A Few Stocks
One common mistake is to be overweight in a few stocks (often in the same industry). When you do this, you put yourself at a higher risk of underperformance in the sector. If a shock affects one of these businesses, it is much more likely to affect them all.
To fix this, change your stock portfolio balance and focus more on selecting companies from the rest of the market. Going in heavy on just a few puts you at risk of missing out on the gains of the winners while focusing on the losers.
Putting Your Money Into A Specific Type Of Company
Another mistake is to put too much capital into companies of the same size. For example, some investors plow all their investments into the big ticket companies without looking for a smaller business for sale to even out their investments. This focus on the big brands robs them of earning higher returns from a smaller company that can return many times their original investment.
You can correct this by buying some of the lesser-known names in the index or simply investing in private equity. Having a range of sizes improves your risk-adjusted return.
Failing To Buy Multiple Asset Classes
Many people put their liquid capital into equities without considering how other asset classes could help them generate a return on their investments. Again, this is a mistake. Equities are highly correlated with themselves (which is why the market tends to crash as a whole), while bitcoin, property, and fine art are less so.
To fix this, follow the standard guidance to keep equities to less than 50 percent of your portfolio. Use the remainder of the funds to buy real estate, bonds, vintage wines, and even classic cars. Look for stores of wealth that don’t relate to each other.
If you are not sure about the correlation levels between these various asset classes, many websites list them in real-time. Search for them on Google
Insufficient Global Exposure
Finally, your portfolio might be less diversified than you think if you have insufficient global exposure. Many people concentrate their assets in their home country without considering those overseas.
This approach is risky because numerous shocks could affect the home country but not elsewhere, crushing returns. You might have a war or political disruption in the U.S., causing asset prices to fall and lead to wealth destruction.
To protect against this, start investing overseas. Look for opportunities to buy foreign companies and assets.
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