What does to diversify your portfolio mean?

A portfolio is a collection of assets. Factors such as risk tolerance, costs, timing and others are essential in keeping a portfolio balanced, and achieving this balance is called diversification.

In finance, a portfolio is the term used for a collection of securities (assets) such as stocks, bonds, currencies and other financial instruments. Investors may also refer to their collection of assets as their portfolio.
In order to mitigate risks, it’s generally considered to be a good idea to diversify one’s portfolio, meaning to balance a portfolio and add variety.
Factors such as risk tolerance, costs, timing, weighting and others are essential for establishing a well-balanced, i.e. diversified portfolio.

What is a portfolio?

If you buy a stock of a company during an IPO or via a broker on a stock exchange, you become a shareholder in that company. If several financial assets like stocks, commodities, currencies, bonds and others are organised and grouped together based on certain criteria, this collection is called a “portfolio”. Such criteria may be a certain market, a market segment or an asset class.

Individual investors also refer to the collection of all their own assets and investments as a “portfolio”. Financial institutions and banks also manage portfolios of all kinds and sizes for investors.

What does diversification mean?

Of course the idea to own just a few assets, such as a few stocks that are similar to each other in nature, sounds quite tempting. Just imagine how convenient it would be to simply check in on them once in a while for performance and that’s it.

Unfortunately, investing does not work this way. Most investors would not be pleased with the outcome of their investment. Instead, one of the fundamental principles of investing is reducing the risk to your assets and you can achieve this through diversification.

Diversifying your portfolio simply means reducing your investment risk by not putting all of your eggs in one basket. You can achieve diversification by having more than one type of investment in your portfolio and distributing the capital you want to invest over a diverse range of financial products.

Why should you diversify your portfolio?

Every investor has a different threshold regarding risks. Some investors are completely against risk. For this reason, they only invest in low-risk assets while accepting lower returns on their investments. As a matter of fact, the fear of risk or not understanding possible risks are the main factors that keep potential investors from investing at all.

Dealing with risk aversion

It’s human nature to want to earn wealth while keeping losses at a minimum. Fears that you are going to lose money are normal. Achieving your own long-term and short-term financial goals, however, may entail accepting some risk to optimise your gains over the long term.

Low-risk financial instruments come with some disadvantages.First of all, you are going to receive very little interest on your investment if you keep your money in a regular savings account, sometimes hardly any interest at all. This will also take its toll on compounding your gains. In addition, inflation is bound to reduce the long-term value of your savings. Keep in mind, with your savings account, that once the rate of inflation is higher than the interest rate you earn on your savings, you are losing money.

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How to diversify your portfolio for optimal spread of risk

Most shareholders do not invest all their money into one company but across several companies and across several industries. This way they “spread” potential risk across many securities. This is called asset allocation and is an element of diversification.

The easiest way to start diversifying is to educate yourself here on the Bitpanda Academy on various financial products - stocks, bonds, mutual funds, ETFs and digital assets - and how they work. Determine how much you would like to invest and the time frame you plan for each financial product. Consider how you feel about investment risk versus rewards generated by earnings. There is a wide range of investment options available as new technologies are opening up opportunities for beginners and small-scale investors alike.

Fractional shares, real estate and precious metals

Thanks to blockchain technology, the rights to almost any asset can be “divided” into very small percentages (fractions) of the total asset value. Therefore, almost anyone past the age of 18 can start investing with very low amounts of money. You simply buy small fractions of assets. In a long-due development towards financial equality, small-scale investors can finally become shareholders.

As a final note: When structuring your portfolio, consider whether you are planning on using your funds in the medium-term for other ventures, such as making a down payment on real estate. This should be a part of your larger budgeting and financial planning process.

This article does not constitute investment advice, nor is it an offer or invitation to purchase any digital assets.

This article is for general purposes of information only and no representation or warranty, either expressed or implied, is made as to, and no reliance should be placed on, the fairness, accuracy, completeness or correctness of this article or opinions contained herein.

Some statements contained in this article may be of future expectations that are based on our current views and assumptions and involve uncertainties that could cause actual results, performance or events which differ from those statements.

None of the Bitpanda GmbH nor any of its affiliates, advisors or representatives shall have any liability whatsoever arising in connection with this article.

Please note that an investment in digital assets carries risks in addition to the opportunities described above.