- Diversifying your investments is a great way to ensure you’re exposed to various parts of the market, so you’re not just banking on a single stock or asset class to do well.
- You need to diversify between different asset classes—holding multiple investments that are all the same type won’t necessarily get you the benefits you’re looking for.
- If you’re looking for relatively stable returns, diversification is a sound strategy.
Understanding diversification when it comes to your investments is one of the best ways to get a handle on the risks involved in investing.
And although it sounds like an advanced topic, if you eat food (which you probably do) you’re already familiar with the basic concept.
If you ate mac and cheese for every meal, it’s easy to see that you’d be missing some key nutrients in your diet, but the same could be said of broccoli. Broccoli is good for you, sure, but it still lacks some nutrients you get from other foods.
That’s why the healthiest diets contain a range of different meals, to make sure you get everything you need to reach your goals.
Healthy diets are diversified.
That’s how you should think of investing.
Investing all of your money in one stock, or even one industry, is just as extreme as a diet consisting of only broccoli, and you’re not getting the benefits of all of the other investments out there.
Different types of investments—known as asset classes—will bring different levels of risk and return to your portfolio, which is why diversifying your portfolio by investing in multiple asset classes is a good move.
A Diversified Portfolio is not just about Volume
“Ok,” you might be thinking, “so if I invest in a lot of things, I’m diversified!”
And while that can be true, it’s not automatically true.
Diversification is about variety, but 100 stocks from the same industry isn’t the kind of variety you want.
To illustrate this, take a look at this chart from Callan. There’s a lot to take in, so let’s just focus on two key years: 2007 and 2008.
In 2007, emerging markets were leading the pack with a whopping 39.38% annual rate of return.
If we took a time machine back to 2007, it’d be easy to look at that number and think to yourself that you should put all your money into emerging markets, because they were outperforming everything!
And as a nod to diversification, you put your money into several different emerging market investments.
However, just one year later, emerging markets fell from the top of the pack to the bottom, with an annual return of negative 53.33%. If you had all your money in emerging markets, 2008 would not have been a great year.
But over that same time period, a truly diversified portfolio still did well.
Even though there were major fluctuations in multiple asset classes over the years, a diversified portfolio performed pretty consistently over that time because it was exposed to all of the asset classes each year—and for most of us, consistent returns are preferable to wild swings in our investments.
Future-proofing your investments
Diversification is also your best strategy when it comes to figuring out which investments will do well.
Instead of trying to spend your time predicting which asset class will be the biggest winner this year—which even the pros can’t do most of the time—you’ll be investing in all of them.
That way, you’re more likely to participate in whichever asset is doing well, no guesswork required.
At the same time, you won’t need to worry quite as much if one specific asset class takes a nosedive, like emerging markets did in 2008. Since you’re not just invested in that one asset class, you’ll have winners to balance out the inevitable not-winners.
That’s how over time, you can use diversification to create a more stable portfolio, and save yourself the stress of trying to pick winners and avoid losers.
If you’re sold on a diversified portfolio, Twine makes it easy.
Twine portfolios are built from ETFs that expose you to multiple asset classes, which as you now know, will help to keep your returns more consistent over time—even when one ETF is doing really well, and other might not be doing so hot.
Investment Diversification Doesn’t Have to be Hard
Just like you stop yourself from eating mac and cheese three times a day because you know it’s not the best move, you should stop yourself from going all in on a particular asset class, or individual investment.
Diversifying your portfolio is the best way to make sure you’re getting what you need out of your investments, and thanks to ETFs and tools like Twine, it’s not that hard to do.
Investing 101: Let’s do this
Investing doesn’t have to be something scary and intimidating, and it’s one of the most powerful ways you can hit your goals and build wealth over the long term.
Make a Plan:
- Should I Save or Invest?
- Understanding the Stock Market
- Long-Term Investing
- The Relationship Between Risk and Return
- Investing for Beginners
- The Benefits of Diversifying Your Investments
- Types of Asset Classes
- 5 Common Investing Mistakes