In the world of investing, diversification is a crucial factor. A strong portfolio is diversified across different assets. Why is this? Because in times of a recession, or a market crash, some assets are more affected than others. For example, in the 2020 market crash, the airline industry suffered a significant hit while Communications Equipment was less affected. In this case, if you had all your investment in the Airline industry, your portfolio would have suffered a significant loss. However, the loss would have been less substantial if you had it spread out between the airline and communication equipment sectors. This is why having a balanced portfolio where the assets are distributed across different investment vehicles is crucial.
When managing my portfolios, I prioritize diversification by spreading my investments across various asset types and sectors. My approach is simple but efficient, and I will share it with you.
Investing information provided in this blog post is solely for educational purposes. Neither IsaveFuture nor its subsidiaries offer advisory or brokerage services, and we do not recommend or advise investors to buy or sell specific stocks, securities, or other investments.
What Is Diversification?
This strategy aims to reduce risk by spreading your investment across asset types like stocks, bonds, real estate, ETFs, etc. There are different ways in which you can diversify your portfolio. One way is by market capitalization (market cap), which refers to how much a company is worth as determined by the stock market. You can calculate the Market capitalization by multiplying the number of a company’s shares outstanding by its stock price per share. You don’t have to calculate this if you don’t want to because it is usually listed on the stock/ETF/Index fund summary page.
The four types of Market Capitalization
| Large Cap | Mid-cap | Small-cap | Micro-cap | |
| Market Value | $10 billion or more | $2 billion to $10 billion | $300 million to $2 billion | $50 million to $300 million. |
| Expected Returns | Increase in share value and dividend payments (lower growth) | Rapid growth potential | greater chance of growth than mid and large-cap. | Possible high returns but very volatile |
| Sample companies | Microsoft Corp (MSFT) & Coca-Cola Co. (KO) | Silicon Laboratories Inc (SLAB) | InvenTrust Properties Corp (IVT) | |
| Risk | Lower risk than Mid-cap | higher risk than large-cap | volatile and riskier | The riskier of all limited liquidity and information |
| ETFs samples | VV | VOT | VBK | IWC |
You can also diversify your portfolio by buying stocks of different GICS sectors (Global Industry Classification Standard). The term GICS Sectors pertains to the classification of companies with comparable business activities, products, or services. For example, the financial sectors include companies that provide financial services like banking, investing, and insurance. While the Consumer Staples sector focuses on the manufacturing and distributing of food, beverages, tobacco, and personal products.
The stock market is divided into 11 GICS sectors. Considering these sectors react differently to specific economic environments, a well-diversified stock portfolio will hold stocks across most sectors. If one sector doesn’t perform well, the others can help you recover the losses.
The 11 sectors of the stock market
Energy
Materials
Industrials
Consumer Discretionary
Consumer Staples
Health Care
Financials
Information Technology
Telecommunication Services
Utilities
Real Estate
A better approach to diversification.
One of the best ways to diversify a portfolio is by buying ETFs and/or Index Funds. These are passively managed security baskets like stocks, bonds, and real estate that you can buy and sell through a brokerage account like Fidelity and Vanguard. These give you instant diversification because they usually have stocks from different sectors. For example, the ETF VOO has 503 large, mid, and small market capitalization companies. These 503 companies also come from all eleven sectors. Therefore, if you buy this ETF, you will be instantly diversified across all sectors and three market capitalizations.
Many financial experts like Warren Buffet, one of the greatest investors of all time, recommend index funds as one of the most effective ways to invest and be diversified. This is what he instructed his wife to do after his passing.
My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P
Warren Buffet
500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to
those attained by most investors.
Here is VOO Sector Composition (%)
Lastly, there are numerous ways to diversify your portfolio effectively, thereby reducing the associated risks. The best part is that you don’t have to be an expert to do it. You can ultimately diversify using ETFs and Index Funds from different sectors. Investing in these particular asset types is the most effective method for many individuals. If you are a beginner and want to learn more, click here to get my free investing guide.
