You'll often hear that it's important to diversify your portfolio as an investor. But what does that really mean?
In a nutshell, there's no single formula for diversification. What it generally means is you want exposure to different segments of the stock market.
Let's say you have $5,000 in your brokerage account, only that entire sum is invested solely in tech stocks. That would be considered a very non-diverse portfolio. On the other hand, if you own $1,000 worth of tech stocks, $1,000 of energy stocks, $1,000 of retail stocks, $1,000 of auto stocks, and $1,000 of bank stocks, that's a more diverse mix of investments.
If you don't diversify your portfolio, you risk taking losses when the sectors you're heavily invested in take a major hit. You might also stunt your portfolio's growth over time, so it's important to do a good job of branching out.
The problem with a lack of diversification
If you don't diversify your holdings, you might end up looking at serious losses if a particular company or segment you're invested in experiences turbulence. Just look at what happened to tech stocks in 2022. That particular industry got battered, and many investors who were heavily loaded on tech stocks saw the value of their portfolios plummet.
That's why it's so important to maintain a mix of investments. If you have a $5,000 portfolio that consists only of tech stocks and the segment takes a beating, your balance might fall to $2,500. But if tech is only one of several industries you're invested in, your balance might only fall to $4,000 if the segment experiences its share of turbulence.
Also, different segments of the market offer their own opportunities to make money over time. So the more you invest in, the more profit you might end up with.
How to build a diversified portfolio
There are a few things you can do to build a diversified portfolio. First, you could simply buy stocks across a range of industries. There's no specific number of stocks that guarantees diversity, but the Motley Fool recommends owning 25 stocks or more.
Another option is to load your portfolio with broad market ETFs, or exchange-traded funds. If you buy shares of an S&P 500 ETF, for example, you'll effectively be investing your money in the 500 largest publicly traded companies.
You should also know that you can own individual stocks in conjunction with ETFs. And you can invest in sector-specific ETFs, too.
For example, let's say you've done your research on tech stocks so you're comfortable choosing specific ones for your portfolio, but you know less about energy stocks. You could simply buy shares of an energy ETF to save yourself the legwork.
All told, it's really important to maintain a diversified portfolio. If you're not sure whether yours is nicely balanced, have a close look and make changes if needed to ensure you're not too heavily invested in the same company or market segment.
