Putting all your eggs in one basket by investing in single stocks increases the risk of potential losses, which is why professional and experienced do-it-yourself (DIY) investors believe that diversification is a fundamental element required in every considered investment strategy.
The cyclical nature of markets and the variable returns that specific asset classes deliver at different times in that cycle and in response to shifting macroeconomic factors make a concentrated investment a risky proposition, particularly during periods of market volatility.
Diversification entails spreading your investment allocations across asset classes, geographies, sectors, companies, styles and themes to reduce overall portfolio risk.
Adequate diversification ensures that when one market, sector or asset class performs poorly, the other investments in your portfolio can help offset some of the losses and balance your average return profile.
This approach also offers a broader set of opportunities, which creates more balance and less volatility in a portfolio, which is what most investors aim for.
Diversification options
DIY investors have various diversification options available to them. These include the ability to diversify across sectors by investing in multiple different company stocks, as well as options to invest in locally listed companies or offshore markets.
Geographic diversification is important because investing in assets from different countries or regions can reduce exposure to specific economic or political events.
Similarly, diversification across sectors spreads investment allocations across various industries to minimise the impact of sector-specific downturns or shocks.
Investing across different asset classes, such as commodities, bonds, treasuries, currencies, gold and private debt, offers broader market exposure.
DIY investors can also implement diversification strategies within the equity portion of a portfolio in various ways.
For example, they could balance consumer staple stocks, which typically weather downturns in an economic cycle as demand for necessities such as food, beverages, and household products remains relatively stable, against growth stocks, which tend to struggle in tough economic conditions.
Accessing baked-in diversification
Accessing exchange-traded funds (ETF) via an online trading platform like Clarity, by Investec, is another efficient and cost-effective way to gain broad exposure to the best-performing local and global investment opportunities.
ETFs offer exposure to a broad basket of company stocks, delivering baked-in diversification that effectively spreads your risk, removing the idiosyncratic risk inherent in investing directly in single stocks.
Investors can also easily invest across sectors, like technology, healthcare, financials or energy, styles like growth and value, or gain exposure to themes like ESG to express their personal investment flair or align with their values and viewpoints.
In addition, ETFs open up opportunities to diversify investments across asset classes, with ETFs available that allow investors to gain exposure to bonds and commodities.
Diversification considerations
How DIY investors allocate their investments as part of a diversified investment strategy will depend on various factors, including their risk tolerance, time horizon, and financial goals.
Before allocating capital across different assets, themes or styles, consider your goals. Defining whether you are saving for retirement, trying to beat the market with the discretionary portion of your portfolio, or aiming to generate extra income will help determine the appropriate allocations.
Your risk tolerance will inform your preferred asset classes or sectors, with risk-averse DIY investors typically opting for a portfolio that skews towards lower-risk options like value stocks and safe-haven assets like gold. These investors typically opt for a balanced portfolio comprised of 60% stocks, 30% bonds and 10% cash.
Investors with a higher risk tolerance may prefer higher allocations to growth stocks like technology companies and sectors like the AI and EV markets. A typical portfolio allocation for a less risk-averse DIY investor seeking market-beating returns would typically have a higher allocation to stocks (up to 70%), with 30% allocated to bonds to provide some stability and income.
It is also beneficial to periodically review your portfolio to ensure it remains aligned with your goals and risk tolerance, and regularly rebalance your allocations should anything change in your view, circumstances or risk appetite, or in response to changing market conditions.
Avoid over-diversification
However, there are also risks associated with too much diversification, as this can increase costs and complexity, especially for DIY investors.
Managing a highly diversified portfolio can become complex for DIY investors, especially if you’re investing in individual stocks. Keeping track of all the different company stocks and their performance can become challenging.
Over-diversification can dilute your potential returns by spreading your exposure to specific investments too thinly, which means you can miss out on the gains from the best-performing stocks, themes or trends.
At the end of the day, diversification doesn’t guarantee profits or eliminate risk, but it can help you manage risk and potentially improve your returns. By carefully considering the risks and benefits of diversification, you can tailor your investment strategy to your unique circumstances and financial goals and build a portfolio suited to your financial goals and risk tolerance.
