Personal Finance
Lesson 16
5 min

What does to diversify your portfolio mean?

What does to diversify your portfolio mean?

  • In connection with finance, a portfolio is the term used for a collection of securities (assets) such as stocks, bonds, currencies and other financial instruments

  • Investors also refer to the collection of their assets as their “portfolio”

  • Factors such as risk tolerance, costs, timing, weighting and others are essential for establishing a well-balanced portfolio

  • Achieving this balance is called “diversifying a portfolio”

In this lesson, you are going to learn what a portfolio is and why diversification of you portfolio is important.

What is a portfolio?

Like you learned in lesson 12 of the Personal Finance section, 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 and why should you diversify your portfolio?

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 just monitor them once in a while for performance - and that is 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. 

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. 

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

Like you learned in lesson 1 of the Personal Finance section, achieving your own long-term and short-term financial goals may entail accepting some risk to optimise your gains over the long term. 

You have already read about the things you need to consider before deciding how and where to invest. For instance, healthy management of your money including your assets and liabilities and creating your budget and emergency fund are prerequisites before you even begin investing.

Once you have everything set up, it is human nature that you want to earn wealth while keeping losses from investing to a minimum. Fears that you are going to lose money are normal. Can you believe that it has even been proven that we place more emphasis on the fear of losing than on the joy of gaining?

Low risk usually means low returns

However, it is a fact that if you choose investing in low-risk financial instruments only, this may cause some disadvantages for you. 

If you keep the part of your income that you employ to build up assets in low-risk financial instruments only, this may cause a number of disadvantages for you. 

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 a 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. How would you keep your investment risks low?

Diversifying your portfolio for optimal spread of risk

For starters, most shareholders do not invest all their money into one company but across several companies in several industries. This way they “spread” potential risk across many securities. This is called asset allocation and is an element of “diversification” - distributing the capital you want to invest over a diverse range of financial products.

 
 
 
 

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So, how can you start planning the diversification of your portfolio?

The easiest way to start 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. Set up your plan including the amount you would like  to invest and the time frame you plan for each financial product. Find out about the way 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 behind asset tokenisation, 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. 

Finally, 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 when structuring your portfolio and also consider investing a part of your funds into digitised precious metals. 

Read about the greatest investment risks in more detail in our next article.

FURTHER READING 

BOOKS

  • Carver, Robert - Smart Portfolios: A Practical Guide to Building and Maintaining Intelligent Investment Portfolios

  • Grey, Wesley R. - DIY Financial Advisor: A Simple Solution to Build and Protect Your Wealth

  • Marks, Howard - Mastering the Market Cycle


LINKS

Freedom from the fear of investment risks

How much money should you invest in stocks

Asset Allocation for Beginners

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.