Investors talk about âDiversificationâ as this great tool to help you invest, but what does it actually look like in your portfolio? Diversification is referred to as âNot putting all of your eggs into one basketâ, but itâs actually quite a bit more than that. A common misconception is that having more holdings makes you a more diversified, investor; This is only partially true. Diversifying into more holdings does make a difference, but thatâs only if you do it right. A broad market index fund like $XEQTor$VFV is considered more diversified than buying a single stock. XEQT holds thousands of companies, and VFV also owns hundreds. This number of holdings definitely diversifies you, but itâs not just about holdings. If an investor holds 100 companies, ALL of which are tiny micro caps that trade under 10 cent a share, youâre not really âdiversifiedâ. The companies are SO incredibly risky that even holding 100 of them still doesnât change that. Iâve seen many new investors say âI have 30 holdings Iâm very diversified!â, but their holdings consist of very high risk companies and their portfolio moves 5% a day. Thatâs why diversification is a lot more than just holdings. Like I said originally, diversifying is more than not putting all of your eggs in one basket, because thereâs different ways you can do that. Simply having more holdings is only one part of diversifying, letâs look at some others. Geographical Diversification: $XEQT for example is not only good for its number of holdings, but also its geographical holdings. It was International Diversification, meaning there are many countryâs stock markets that are included in the fund. This allows your portfolio to not be subject to one country (like the US) and its market Asset Diversification: Stocks are not the only asset you can own. Many people have 100% equities, but multiple other kinds of assets also can appreciate in value and add diversification. Real Estate, Fixed Income, Precious Metals, Bitcoin, Collectibles, all offer different kinds of investment opportunities that differ from just owning stocks. Sector Diversification: This is a big one thatâs overlooked. Many investors go all in on one sector, in recent years itâs Technology. Owning one sector alone puts you at risk of longer and larger drawdowns in your investment lifestyle. If you owned the NASDAQ post 2000, you would have taken 15 years to recover from an 80% drawdown, thatâs not something to take lightly. This also applies to those owning individual stocks. Your companies may be doing great and continue to, but if all you own is 10 tech businesses, no matter how good the businesses are youâll be hit HARD in a bear market. Diversifying outside of 1 sector means your portfolio will move in different directions thereby reducing your risk and volatility. Now those all seem pretty obvious ways to diversify, but thereâs other ways to diversify especially for those who choose to be more concentrated and buy things like individual stocks. Just because youâre more risky, doesnât mean you canât take safety precautions. Sector diversification is still big, if your stocks are all in one sector youâll be hit even harder than the sector as a whole in the future. Another one is revenue diversification and itâs a big one. Owning businesses that have diversified revenue means the business is less likely to all of a sudden lose all of its income. Payfare was a business that operated closely with DoorDash. However, the revenue for Payfare was 75% from DoorDash. The company then proceeded to lose the contract, and overnight the share price fell 75%. Their revenue wasnât diversified, and shareholders took the brunt of the consequences. You can also diversify your businesses with low volatility. Most investors cannot handle moves of 5% a day. You can focus on low volatility or businesses that move in low beta to the market. This helps you take the hit on bad days or prolonged red markets since not all your stocks are directly tied to the index. Position sizing is another big one for diversifying your portfolio. If you donât want extreme risk, you can position your investments accordingly. Rather than buying a stock and making it 40% of your portfolio, size it according to the risk you can handle and what it could grow to. If you owned $NVDA or $AMD as 25-50% of your portfolio, youâre now almost entirely tied to the business movements of those companies. It doesnât fully matter about the other stocks you own, it NVIDIA plummets, youâll be down with it. If instead you had it at 10% of your portfolio, your daily swings and long-term risk drops significantly since youâre not tied to the success of one business. Having positions at 5 or 10% instead of 50% means youâre much less affected by any investment at any given time, other investments can balance out your daily swings. Being concentrated or âriskyâ does not mean you need to throw risk management and diversification out the window. Even if you have a riskier portfolios, there are still ways to protect yourself from bad decisions and create longevity in any market. Remember, risk is only easy to handle when youâre making money, what happens when you actually start losing it? As always, do your research and happy investing!
