One of the biggest rules to follow as an investor is to ‘not put all of your eggs in one basket’. If you put all your funds into one investment and that investment fails, you’ve lost all your money. However, if you spread out your funds across a range of different investments, the risk of losing it all at once is greatly reduced. This is known as diversifying one’s portfolio.
What a lot of investors don’t realise is that there’s more to diversifying a portfolio than simply investing in lots of different things. The way you divide your funds is important to consider. Below are a few mistakes to avoid when diversifying.
Over-diversifying
Sometimes referred to as ‘diworsification’, over-diversifying involves spreading your funds out too thin by investing in too many different things. While this can eliminate risk, it can greatly reduce your returns. It also becomes much harder to keep track of all your investments.
Over-diversifying has become more common in recent years due to many more affordable investment options like fractional shares and even fractional property ownership. This has led to investors with portfolios of over 100 different investments. If one of these investments skyrockets in value and you’ve only put a few dollars into it, you’re not going to make much of a return. Similarly, you may not notice if an investment plummets in value and you need to sell it.
There is no golden rule as to how many different things you should invest in. A lot of stock trading experts recommend 25 to 30 different stocks in your portfolio. It likely depends on how much money you have to invest. If you’ve only got a small fund to invest with, you may want to stick to less investments. Try to invest in a minimum of 5 different instruments if you can.
Distributing funds unevenly
It’s important to consider your portfolio as a pie, with each slice as similar in size as possible. 70% of this pie should not be taken up by one investment instrument. If this investment goes south, that’s 70% of your portfolio experiencing a loss.
Ideally, if you’re investing in 5 different things, you should aim to put 20% of your funds into each investment. This minimizes any potential losses. With a portfolio of 20+ instruments you may be able to get away with investing a little more into certain instruments without incurring too much risk. Make sure that no more than 20% of your portfolio is dedicated to one instrument.
Sticking to one type of instrument
A portfolio made up of lots of different stocks from lots of different industry sectors might seem secure. But should you be investing solely in stocks?
During stock market crashes, stocks across the board are affected. While the stock market has slowly recovered each time, it may not be much help if you need to access your funds quickly at that exact point. This is why some investors diversify into savings accounts, bonds and gold – instruments that have been known to be unaffected or even rise in value (as has occasionally been the case with gold) during a stock market crash/recession.
At the very least, you should try not to invest in instruments that are closely related. Some investors have a stocks portfolio made up almost entirely of tech company stocks, which is not wise if a calamity affects the entire tech industry. Similarly, some people invest in overly similar or overlapping instruments – such as mutual funds and ETFs that contain the same holdings.
Not diversifying by risk
The ideal portfolio should contain a mixture of high-risk, medium-risk and low-risk investments. If all your investments are high risk, you increase the risk of loss. If all your investments are low risk, you reduce the amount of returns you’re likely to make.
For example, when investing in different cryptocurrencies, you don’t want to be investing everything into volatile coins like Bitcoin and Sealana. Investing some of your funds into stablecoins like USDT can balance out the risk.
Savings accounts and bonds are typically some of the lowest risk investments. IPOs, venture capital and penny stocks are meanwhile some of the highest risk investments.
Investing in things you don’t understand
In an attempt to diversify, some investors try investing in things that they don’t fully understand. This can be dangerous, as it could mean investing in things without fully understanding the risks or not accounting for certain fees.
It’s recommended that you invest in things you have a passion and knowledge of. For example, investing in vinyl could be a sensible option if you have a passion for music. If you need to diversify, educate yourself before you part with your money. You don’t want to get stung, because you underestimate the risks or you overlooked certain fees.
Not getting investment advice
All investors can benefit from seeking out professional advice. It can be particularly wise when considering diversifying into things that you don’t fully understand. Even if you consider yourself knowledgeable, you could find that a professional third party opinion is still useful.
You’ll find lots of advisors that specialise in areas like stock trading or real estate. There are also investment consultants out there like Rachel Buscall of New Capital Link that can help you explore alternative investments for high net worth investors. These professionals can answer any questions you have and help point you towards the right investments. Make sure to consider what fees they charge.
Failing to monitor your portfolio
An obvious but common mistake that investors make is not regularly monitoring their portfolio. A lot of first-time investors check their investment daily, but over the years you may find yourself going weeks or months without checking your portfolio. This could result in you reacting late to major fluctuations in value where it could be important to sell instruments or buy more.
By monitoring your portfolio regularly, you can react fast to any major incidents. Automated alerts are possible to set up on many portfolio management platforms – these can alert you if an instrument reaches a certain value, so you don’t have to check your portfolio religiously. Alternatively, some people simply hire someone to monitor and manage their investments for them.
