In the investment field, investment diversification is a widely recognized important strategy, which is of key significance for investors to achieve steady asset growth and effective risk management. Here is an introduction to the meaning of portfolio diversification and suggestions to help you quickly diversify your portfolio.
What is portfolio diversification ?
Portfolio diversification refers to investors allocating funds to a variety of asset classes and targets based on the risk-return characteristics of different assets. Its fundamental purpose is to utilize the correlation differences between assets to reduce the impact of the volatility of a single asset on the overall portfolio, thereby reducing investment risks and stabilizing investment returns.
From a theoretical perspective, Modern Portfolio Theory (MPT) suggests that through asset diversification, risk can be reduced without reducing expected returns. For example, in a simple investment portfolio, stock assets generally have higher return potential but are accompanied by greater volatility, while bond assets have relatively stable returns with less volatility. When the stock market falls sharply due to a macroeconomic recession or industry crisis, bond prices may remain stable or even rise, thereby partially offsetting the losses of stock assets and stabilizing the value of the portfolio.
In actual market performance, taking the global financial market turmoil caused by the COVID-19 pandemic in 2020 as an example, many single-asset investment portfolios suffered heavy losses. For example, investors who only hold a large position in technology stocks saw their net asset value shrink sharply when technology stocks fell sharply at the beginning of the epidemic. However, a diversified investment portfolio, if it also includes stocks in industries such as healthcare, consumer staples, and utilities, as well as assets such as bonds and gold, has relatively small overall losses as these assets have shown different price trends during the epidemic, and some even recovered quickly after the market stabilized, reflecting strong risk resistance.
How to build a diversified investment portfolio ?
A diversified portfolio should include a wide range of investments. For years, many financial advisors have recommended a 60/40 portfolio, with 60% of funds in stocks and 40% in fixed-income investments such as bonds. Meanwhile, others have advocated increasing exposure to stocks, especially for younger investors.
One of the keys to a diversified portfolio is to own a variety of different stocks. This means owning technology stocks, energy stocks, and healthcare stocks, among other industries. Investors don't need to be in every industry, but should focus on owning a variety of high-quality companies. In addition, investors should consider large-cap stocks, small-cap stocks, dividend stocks, growth stocks, and value stocks.
In addition to having a diversified stock portfolio, investors should also consider holding some non-correlated investments (for example, those whose prices do not fluctuate with the daily movements of stock market indices). Non-stock diversification options include bonds, bank certificates of deposit ( CDs ) , gold, cryptocurrencies, and real estate.
How to diversify your investment portfolio ?
Efficient use of index funds and ETFs: For ordinary investors, index funds and exchange-traded funds (ETFs) are convenient tools for achieving investment diversification.
Index funds provide investors with broad market exposure by replicating the composition and weighting of constituent stocks of a specific market index. For example, the CSI 300 Index Fund covers 300 companies with large market capitalization and good liquidity in the Shanghai and Shenzhen stock markets. When investors purchase this fund, it is equivalent to investing in a portfolio of high-quality companies in multiple industries with one click, diversifying individual stock risks and obtaining market average returns. At the same time, the management fees of index funds are relatively low, which reduces investment costs.
ETFs have the advantages of low transaction costs, flexible transactions, and high transparency. They are listed and traded on the stock exchange like stocks, and investors can buy and sell them in real time during trading. Some ETFs can also achieve T+0 transactions, which enhances the liquidity of funds. For example, gold ETFs closely track the trend of gold prices. Investors do not need to actually hold gold, but can conveniently participate in gold market investment through securities accounts, realize asset diversification, and avoid the inconvenience and cost of physical transactions such as gold storage and transportation.
Strategic implementation of global asset allocation: Global asset allocation is an important way to enhance the diversification of investment portfolios. Investors can invest in overseas markets through qualified domestic institutional investors (QDII) funds, cross-border ETFs, etc.
QDII funds invest in a wide range of assets, including overseas stocks, bonds, real estate, etc. For example, some QDII funds focus on investing in US technology stocks or the bond markets of emerging market countries, providing investors with opportunities to share the fruits of global economic growth and diversify domestic market risks. By analyzing economic data, interest rate policies, exchange rate trends and other factors in different countries and regions, and rationally allocating QDII funds, the risk- return structure of the investment portfolio can be optimized.
Cross-border ETFs provide convenience for investors to directly invest in overseas markets. For example, cross-border ETFs that invest in the S&P 500 index enable investors to participate in U.S. stock market investments and obtain market returns from the world's largest economy. At the same time, cross-border ETFs can be traded intraday, and investors can adjust their investment portfolios in a timely manner according to global market dynamics, enhancing investment flexibility and initiative.
Scientific operation of regular rebalancing: Regular rebalancing is a key link in maintaining the stability of the diversified structure of the investment portfolio. As the market fluctuates, the weights of each asset in the investment portfolio will change and deviate from the initial allocation ratio.
Investors can set a quarterly or semi-annual rebalancing cycle. For example, during a period of sharp rise in the stock market, the weight of stock assets in the portfolio may exceed the predetermined ratio. At this time, some stocks should be sold and funds should be reallocated to assets such as bonds and cash equivalents to restore the portfolio to the target allocation ratio. Conversely, when the stock market falls, if the weight of stock assets is too low, stocks can be appropriately increased. In this way, investors can keep the risk-return characteristics of the investment portfolio stable during market fluctuations and avoid increasing risks due to excessive asset concentration or imbalanced allocation.
Conclusion
Investment diversification is a core strategy for investors to deal with risks in the financial markets and achieve long-term stable growth of assets . It reduces investors' exposure to a single stock, industry or investment option. While this may reduce investors' return potential, it also reduces volatility and, more importantly, reduces the risk of bad results. Investors should take diversification seriously.
