How to diversify your investments
Diversify your investments by spreading exposure across asset classes and within each asset class. Then check what your funds own, because several funds can leave you concentrated in the same companies, sectors or markets.
Diversification can reduce the damage caused by one investment or one part of the market performing badly. It cannot guarantee a profit, remove every investment risk or prevent losses during a broad market decline.
What risks can diversification reduce?
Diversification primarily reduces concentration risk: the risk that one company, issuer, sector, country or asset class has too much influence on your result. A serious loss in one holding then affects a smaller part of the portfolio.
It is most effective against risks tied to a particular company, bond issuer or narrow market segment. Combining investments that respond differently to economic conditions may also reduce fluctuations at the portfolio level. FINRA explains that investment risk cannot be eliminated, although asset allocation and diversification can help manage different forms of risk.
Ask what would happen to your total portfolio if its largest holding, sector, issuer or market suffered a major loss. A large answer points to concentration that deserves closer review.
How do you diversify across asset classes?
Diversifying across asset classes means holding investments with different sources of return and different risks. Stocks, bonds, cash and property can react differently to growth, inflation, interest rates and market stress.
The appropriate amount in each class depends on your objectives, time horizon, need for liquidity and capacity for loss. Those choices belong to the wider process of building an investment portfolio. Diversification starts after you have decided which asset classes have a role.
| Asset class | Possible portfolio role | Concentration to check |
|---|---|---|
| Stocks | Long-term growth and company ownership | One company, sector, country or market type |
| Bonds | Income, capital stability or lower volatility | One issuer, credit category, maturity range or currency |
| Cash | Liquidity and near-term spending needs | One bank, currency or cash product |
| Property | Income, real-asset exposure or direct use | One building, location, tenant type or property sector |
Cash and direct property require separate decisions because their liquidity and concentration can differ sharply from listed funds. See the roles of cash in a portfolio and the trade-offs of property as an asset.
How do you diversify within an asset class?
Diversification within an asset class means spreading exposure among holdings that do not depend on the same company, issuer or market segment. A portfolio can contain several investments and still be concentrated if they share the same main risks.
Within stocks, review companies, sectors, company sizes and countries. Within bonds, review issuers, credit quality, maturities and currencies. Within property, review locations, property types and tenants. Investor.gov describes diversification both across asset classes and among investments within each class.
- Count distinct exposures rather than the number of account lines.
- Check whether several holdings depend on the same economic conditions.
- Look for large positions created by market gains, employer shares or inherited assets.
- Include investments held across retirement, brokerage and other accounts.
Can several funds still leave you concentrated?
Yes. Several mutual funds or exchange-traded funds can own many of the same securities. Funds with different names may track related indexes, favor the same large companies or concentrate on the same sector or country.
Compare each fund’s largest holdings and its weights by asset type, sector and region. Investor.gov notes that shareholder reports show fund holdings by categories and may list the ten largest positions. The fund’s current holdings page can provide more recent information, especially for ETFs that disclose holdings frequently.
Owning five funds does not create five distinct sources of risk when the same companies dominate all five. Measure the combined exposure to the shared holdings.
What can diversification not protect against?
Diversification cannot guarantee gains or prevent losses when broad markets fall together. It reduces selected risks; the remaining risks depend on what you own and how those investments respond to the same event.
It also cannot correct a portfolio that takes more risk than you can afford, create cash for a near-term expense or stop an investor from selling during a decline. Decide first whether money should remain liquid by comparing saving and investing.
- Market risk: broad stock, bond or property markets can decline.
- Inflation and interest-rate risk: these can affect several holdings at the same time.
- Liquidity risk: an asset may be difficult or costly to sell when cash is needed.
- Currency and political risk: international exposure can add risks as well as spread them.
- Investor behavior: changing course during stress can defeat the intended portfolio plan.
How can you check your portfolio’s diversification?
Check diversification by combining every investment account and measuring the exposures beneath the product names. Review both the broad asset mix and the largest concentrations within each asset class.
- List all accounts, individual securities, funds, cash and direct property.
- Group them by asset class and calculate each class’s share of the total.
- Look through funds to their major holdings, sectors, regions and bond characteristics.
- Add repeated exposures across funds and accounts.
- Identify the companies, issuers, sectors, countries and assets that could drive a large loss.
- Compare the result with your intended allocation and review it after major portfolio changes.
Use the result to prevent one avoidable source of risk from determining too much of the outcome.