How to Diversify Your Investment Portfolio – Tips for Newbies

Knowing how to diversify your investment portfolio is the first step to financial security – and even wealth! A financial expert, Mark J. Aubry, explains what diversifying your portfolio means, and shares three investment tips.

Before the tips, a quip:

“Diversification is the closest thing to a free lunch.  You might as well eat a lot of it.” Kenneth French.

For a wide range of investment tips, click on Warren Buffett Invests Like a Girl: And Why You Should, Too (Motley Fool).

And, read on for Aubry’s info on how to diversify your investment portfolio…

How to Diversify Your Investment Portfolio

Remember that investment diversification means different things to different people

To some, diversifying your portfolio means not having just one, but five different technology stocks.  For others, including some financial talk show gurus, diversification means owning one or two stocks that represent different sectors.  Still, some choose to pick mutual funds, where diversification may mean only owning “best of breed” funds that track past performance.  Our firm’s approach is to provide global diversity.  Specifically, our portfolios have more than 12,000 securities (stocks and bonds) in 40 different countries. This is achieved whether a client has a $5,000 portfolio or a $50,000,000 portfolio.

Diversification provides two main benefits to investors:

  1. A diverse portfolio reduces uncertainty or financial risk by pooling a wide variety of investments within a portfolio.
  2. A diverse portfolio increases the expected return of the portfolio.

Long-term investments in a globally diversified portfolio can bring greater returns with essentially the same levels of risk.

3 Tips for Newbies for Diversifying Investment Portfolios

1. Develop your portfolios using three main factors:

  1. Over time, stocks provide better returns than bonds;
  2. Over time, small company stocks provide better returns than larger company stocks;
  3. Over time, value company stocks provide better returns than growth company stocks.

2. Beware of “home bias.” This is “the tendency for investors all over the world to commit more of their portfolio to equities in their domestic market than they should.” (quote attributable to Bradley G. Steiman, Director and VP, Dimensional Fund Advisors Canada, Inc). Read Tips for Picking and Investing in Stocks for more investment tips.

3. Consider not having exposure of more than 50% in any one country, including the United States.  While this is definitely different than most, the evidence provided by the history of the capital markets strongly supports this view.

Do you have questions or tips on diversifying your investment portfolio? Comments welcome below!

Aubry also contributed The Benefits of Short-Term Versus Long-Term Investments, here on Quips & Tips for Achieving Your Goals.

Mark J. Aubry is the Managing Director of a US-based planning and advisory firm, Aubry & Eustice, which helps clients simplify confusing and overwhelming topics.  Through customized and coordinated solutions, the firm helps clients move Beyond Financial Planning.

Leave a Reply

Your email address will not be published. Required fields are marked *

2 thoughts on “How to Diversify Your Investment Portfolio – Tips for Newbies”

  1. Here’s an example of investment diversification:

    If an investor were looking to decrease long-term uncertainty and increase their long-term returns, that investor may develop an equity portfolio that would track the following indices:

    12.5% S&P 500 Index
    12.5% Russell 1000 Value Index
    12.5% Russell 2000 Growth Index
    12.5% Russell 2000 Value Index
    20% MSCI World ex-USA Small Cap Index
    20% MSCI World ex-USA Index
    10% MSCI Emerging Markets Index

    With this unique approach to diversification, two surprises emerge in the resulting data:

    During the ten year period ending March 31, 2009, the S&P 500 had an annualized return of -3.00%, the EFAE Index had an annualized return of -0.47%, and the example portfolio mentioned above would have had an annualized return of 2.00%.

    While it would seem that this portfolio is exposed to more “risky” investments (the international and emerging markets), most investors would be surprised to see that this is not true. The S&P 500, EAFE Index and the example portfolio all have very similar levels of volatility, which is how many investors measure risk. In the time period mentioned above, the annualized standard deviation (the measure of volatility) are as follows: S&P 500 = 15.80%; EAFE Index = 17.09%; Example Portfolio = 16.96%.

    What does this mean? Well, if one invests for the future with a globally diversified portfolio, the investor should expect to see greater returns with essentially the same levels of risk.