Creating a Diversified Stock Portfolio

Read our Advertiser Disclosure.
Contributor, Benzinga
January 30, 2023

Financial markets are always heading to an uncertain future. To avoid a journey that’s fraught with losses, you need a portfolio that helps you manage risk. A well-diversified portfolio consists of several asset classes, further diversified into investments.

By creating a diversified portfolio, you strive to protect yourself from all types of market conditions. 

The goal of diversification is to minimize losses and increase potential profits. Investing in one asset may not achieve that outcome, so you need a strategy that provides a stable journey when the market swings high and low.

How to Create a Diversified Portfolio

Creating a diversified portfolio requires you to incorporate several aspects likely to provide protection against unfavorable market conditions.

1. Diversify Within Asset Classes

After identifying assets with which to build your portfolio, spread the investments further. The most common assets investors choose are stocks and bonds. But you shouldn’t rely on a single stock or a bond. 

Spread the risk in stocks by investing in different industries. Even during economic hardships some energy and healthcare stocks outperformed the market because these industries are crucial for survival. 

Owning stocks in various companies in the same industries may not diversify your portfolio. The dotcom bubble provided many investors who owned shares in various technology companies with losses.

Consider adding short-term investments such as high-yield savings accounts and short-term corporate bonds. Gold and commodities are popular inflation hedges. These assets are highly liquid, enabling you to convert them into cash quickly.

Having cash in your portfolio enables you to buy assets at affordable prices during a market downturn.

2. Index Funds Offer Stock Diversification

Picking individual stocks to build the equities portion of your portfolio can be challenging. 

The easiest way to diversify is by investing in a mutual fund or an exchange-traded fund (ETF) that tracks a popular index such as the S&P 500. This market index represents the stock performance of 500 of the biggest public companies in the U.S.

This long-term diversification strategy can provide passive income at low fees. Indexes that are passively managed adopt a hands-off approach, which can minimize returns.

To achieve higher returns, you’ll need an actively managed portfolio tracking indexes proven to provide aggressive growth. These types of indexes carry higher risk and fees than traditional ones tracking the S&P 500.

3. Rebalance Your Portfolio

Profits are recognized only once you’ve locked them in. Keeping a profitable position open is gains realized on paper, which have not yet been converted into physical cash. 

Rebalancing your portfolio requires you to track it. Once you are satisfied with the returns of a particular asset, you need to sell it and divert the cash to other assets. Not selling an asset that has surged in value can result in it losing the gains if it reverses.

A part of rebalancing your portfolio requires recognizing current market conditions and preempting future ones. It involves diverting funds from an asset that performs poorly in certain conditions to one that serves as a hedge. 

During inflationary periods, bonds tend to outperform stocks. You might want to consider reducing your stock holding and adding more weight to bonds to maintain portfolio balance.

The problem many new investors face is rebalancing too frequently because they have an emotional response to market movements. While a time rule for rebalancing isn’t set in stone, monitor your portfolio at least twice annually.

Your strategy may change over time. When you are decades away from retirement, you can afford to invest in risky assets because you have time to recoup losses. As you approach retirement, you may opt for a conservative portfolio to increase your chances of living a comfortable post-employment life.

4. Think Abroad

A portfolio doesn’t have to be limited to domestic assets. Investing in foreign assets provides you with further opportunities and minimizes risks associated with domestic market conditions. 

Inflation in the U.S. may affect the majority of your portfolio if it’s largely made up of U.S. stocks.

But having foreign stocks in your portfolio provides you with exposure to emerging markets such as India and China.

5. Dollar-Cost Averaging

Discipline is important in investing to ensure that your portfolio grows. By allocating a specific amount of money to investments every month, you reduce your risk by investing at different prices. 

As an example, investing $1,000 monthly in a stock with a price of $100 and then decreasing to $50 and $40 in the subsequent months results in owning a stock that averages a price of $55. 

$1,000/100 = 10 shares

$1,000/50= 20 shares

$1000/40 = 25 shares

$3,000/55 shares= $55

Besides reducing risk, dollar-cost averaging enforces disciplined investing, prevents bad timing and manages emotional investing.

Benefits of a Diverse Investment Portfolio

Diversifying your portfolio provides you with several benefits.

Minimizes risk: When your portfolio contains uncorrelated assets, the profits realized from one asset are offset against the losses of a poorly performing asset.

Provides opportunities to various markets: Having a portfolio that consists of different assets enables you to own different types of stocks in various industries. You gain exposure to global markets and potential returns associated with emerging economies.

Offers peace of mind: You’re less likely to be stressed about your portfolio and monitor it frequently for volatility when it’s diversified.

How Much Diversification is Required?

It’s possible to be over-diversified. That results in higher fees and potential overlapping of investments providing the same results.

The point of diversification is to reduce risk and optimize profits from different asset classes by avoiding funds in the same category. You’re not diversifying by holding only several stocks in small-cap companies. 

A common guideline is to invest in 20 to 30 stocks in different industries or an index fund that consists of such equities.

Compare Stock Brokers

Achieving portfolio diversification requires you to use brokers that offer various asset classes and low fees. Benzinga found affordable brokers that manage your portfolio for you and enable you to adopt a hands-on approach.

Frequently Asked Questions

Q

What is an example of a diversified portfolio?

A

Portfolios are diversified based on your risk appetite. Experts generally say that a balanced portfolio consists of 40% of long-term bonds, 35% stocks, 15% foreign stocks and 10% short-term investments. This mix of assets has historically yielded an average annual return of 7.99% and a best 12-month return of 76.57%.

Q

How much cash should be in a diversified portfolio?

A

Holding cash enables you to buy assets at low prices during market crashes. The common practice is to have 5% to 10% of your portfolio in cash. 

About Goran Radanovic

Equities, Forex, Crypto