3 Tips for a Diversified Portfolio | The Motley Fool (2024)

Most people have heard the old saying, "Don't put all your eggs in one basket." The logic: If a farmer were to stumble while bringing the basket of eggs back from the henhouse, they could end up with a messy situation. Those words of wisdom go well beyond farming; they also perfectly encapsulate the idea of not risking all your money on a single investment.

One way investors can reduce their risk of a cracked nest egg is by diversifying their portfolio. Here's a look at what that means, as well as three tips to help you quickly diversify your investments.

3 Tips for a Diversified Portfolio | The Motley Fool (1)

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Definition

What is portfolio diversification, and why does it matter?

A diversified portfolio is a collection of different investments that combine to reduce an investor's overall risk profile. Diversification includes owning stocks from several different industries, countries, and risk profiles, as well as other investments such as bonds, commodities, and real estate. These various assets work together to reduce an investor's risk of a permanent loss of capital and their portfolio's overall volatility. In exchange, the returns from a diversified portfolio tend to be lower than what an investor might earn if they were able to pick a single winning stock.

How to build

What goes into a diversified portfolio?

A diversified portfolio should have a broad mix of investments. For years, many financial advisors recommended building a 60/40 portfolio, allocating 60% of capital to stocks and 40% to fixed-income investments such as bonds. Meanwhile, others have argued for more stock exposure, especially for younger investors.

One of the keys to a diversified portfolio is owning a wide variety of different stocks. That means holding a mix oftech stocks,energy stocks, and healthcare stocks, as well as some from other industries. An investor doesn't need exposure to every sector but should focus on holding a wide variety of high-quality companies. Further, investors should consider large-cap stocks,small-cap stocks,dividend stocks,growth stocks, andvalue stocks.

In addition to owning a diversified stock portfolio, investors should also consider holding some non-correlated investments (e.g., those whose prices don't ebb and flow with the daily gyrations of stock market indexes). Non-stock diversification options include bonds, bank certificates of deposit (CDs), gold, cryptocurrencies, and real estate.

Tips

Three tips for building a diversified portfolio

Building a diversified portfolio can seem like a daunting task since there are so many investment options. Here are three tips to make it easy for beginners to diversify.

1. Buy at least 25 stocks across various industries (or buy an index fund)

One of the quickest ways to build a diversified portfolio is to invest in several stocks. A good rule of thumb is to own at least 25 different companies.

However, it's important that they also be from a variety of industries. Although it might be tempting to purchase shares of a dozen well-known tech giants and call it a day, that's not proper diversification. If tech spending takes a hit due to an economic slowdown or new government regulations, all those companies' shares could decline in unison. Investors should make sure they spread their investment dollars around several industries.

One quick way to do that for those who don't have the time to research stocks is to buy anindex fund. For example, anindex fund will aim to match the S&P 500's performance. The benefit of index funds is that they take a lot of guesswork out of investing while offering instant diversification. For example, with an , you're buying shares of a single fund that gives you exposure to 500 of the largest public U.S. companies.

Another great thing about index funds is that their fees -- known as expense ratios -- are very low. That's because, with the best index funds, you're not paying for the expertise of a fund manager who's going to research and hand-pick investments for you.

2. Put a portion of your portfolio into fixed income

Another important step in diversifying a portfolio is to invest some capital in fixed-income assets like bonds. While this will reduce a portfolio's overall returns, it will also lessen the overall risk profile and volatility. Here's a look at some historical risk-return data on a variety of portfolio allocation models:

Data source: Vanguard. Return data from 1926 to 2021.
Portfolio MixAverage Annual ReturnBest YearWorst YearYears with a Loss
100% bonds6.3%45.5%(8.1%)20 out of 96
80% bonds and 20% stocks7.5%40.7%(10.1%)16 out of 96
40% bonds and 60% stocks9.9%36.7%(26.6%)22 out of 96
20% bonds and 80% stocks11.1%45.4%(34.9%)24 out of 96
100% stocks12.3%54.2%(43.1%)25 out of 96

Although adding some bonds reduces a portfolio's average annual rate of return, it also tends to mute the loss in the worst year and cut down on the number of years with a loss.

While picking bonds can be even more daunting than selecting stocks, there are easy ways to get some fixed-income exposure. One of them is to buy a bond-focused exchange-traded fund (ETF).

3. Consider investing a portion in real estate

Investors who want to take their portfolio diversification to another level should consider adding real estate to the mix. Real estate has historically increased a portfolio's total return while reducing its overall volatility.

An easy way to do this is by investing in real estate investment trusts (REITs), which own income-producing commercial real estate. The sector has an excellent track record. In the 25-year period ending in 2021, REITs, as measured by the FTSE Nareit All Equity REIT Index, generated an average annual total return of 11.5%.

Several studies have found that an optimal portfolio will include a 5% to 15% allocation to REITs. For example, a portfolio with 55% stocks, 35% bonds, and 10% REITs has historically outperformed a 60% stock/40% bond portfolio with only slightly more volatility while matching the returns of an 80% stock/20% bond portfolio with less volatility.

Related investing topics

Accounts That Earn Compounding InterestInterest compounds when interest payments also earn interest. Learn how to get compounding interest working for your portfolio.
How to Invest in ETFs for BeginnersExchange-traded funds let an investor buy lots of stocks and bonds at once.
How to Research StocksGood research can help investors find the best companies to invest in.
How to Find Investment IdeasNew ideas are the way to make money in the markets. Find inspiration here.

Diversification reduces the risk of cracking your nest egg

Diversification is about tradeoffs. It reduces an investor's exposure to a single stock, industry, or investment option. While that can potentially cut into an investor's return potential, it also reduces volatility and, more importantly, the risk of a bad outcome. Investors should take diversification seriously. Otherwise, they're taking a big gamble that an outsized bet won't spoil their hopes of expanding their nest egg to support them in their golden years.

FAQs on portfolio diversification

What is a well-diversified portfolio?

A well-diversified portfolio invests in many different asset classes. It has a relatively low allocation to any single security. Because of that, if one security significantly underperforms, it won't have a meaningful impact on the portfolio's overall return. However, a well-diversified portfolio will typically deliver returns that roughly match those of the overall market.

What is considered a diversified portfolio?

A diversified portfolio contains a mix of asset types and investment vehicles. A diversified portfolio will typically hold several different stocks. An ideal diversified portfolio would include companies from various industries, those in different stages of their growth cycle (e.g., early stage and mature), some companies from foreign countries, and companies across a range of market capitalizations (small, mid, and large). In addition, it would hold bonds, cash, real estate, and commodities.

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3 Tips for a Diversified Portfolio | The Motley Fool (2024)

FAQs

3 Tips for a Diversified Portfolio | The Motley Fool? ›

A diversified portfolio will typically contain 4 primary components - domestic stocks, international stocks, bonds, and cash. Sometimes mutual funds will feature instead of international stocks. Domestic stocks - These will nearly always feature heavily in any given portfolio.

What are the 4 primary components of a diversified portfolio? ›

A diversified portfolio will typically contain 4 primary components - domestic stocks, international stocks, bonds, and cash. Sometimes mutual funds will feature instead of international stocks. Domestic stocks - These will nearly always feature heavily in any given portfolio.

What is Motley Fool's ultimate portfolio? ›

The Ultimate Portfolio is a carefully curated model portfolio created by Motley Fool's expert analysts. Its purpose is to offer a strategic roadmap that can lead to long-term investment success.

What is the perfect diversified portfolio? ›

Having a mixture of equities (stocks), fixed income investments (bonds), cash and cash equivalents, and real assets including property can help you maintain a well-balanced portfolio. Generally, it's wise to include at least two different asset classes if you want a diversified portfolio.

Does a diversified portfolio beat the S&P 500? ›

A diversified portfolio might outperform or underperform an index such as the S&P 500, which only measures U.S. large cap stocks, on any given day, quarter or year. But short-term returns are not a long-term investment plan.

What are the 4 Ps of portfolio management? ›

These are People, Philosophy, Process, and Performance. When evaluating a wealth manager, these are the key areas to think about. The 4P's can be dissected further, but for the purpose of this introduction, we'll focus on these high-level categories.

What are the 3 key elements of portfolio management? ›

Some individuals do their own investment portfolio management. That requires a basic understanding of the key elements of portfolio building and maintenance that make for success, including asset allocation, diversification, and rebalancing.

What is Bill Gates investment portfolio? ›

Bill Gates Portfolio: 7 Best Stocks to Buy Now
STOCK% OF PORTFOLIOMARKET VALUE OF SHARES
Microsoft Corp. (MSFT)33.5%$15.4 billion
Waste Management Inc. (WM)16.4%$7.5 billion
Berkshire Hathaway Inc. (BRK.B)15.9%$7.3 billion
Canadian National Railway Co. (CNI)15.8%$7.2 billion
3 more rows
May 22, 2024

Is Motley Fool's Market Pass worth it? ›

At $89 for the first year, with a 30 day membership-fee back guarantee, and based on both their recent and historical performance, Motley Fool Stock Advisor is absolutely worth it. You should absolutely get the Motley Fool's next 24 stock recommendations, plus access to all their recent picks, and try it out.

What is Warren Buffett's portfolio? ›

The current portfolio value is calculated to be $331.68 Bil. The turnover rate is 1%. In Warren Buffett's current portfolio as of 2024-03-31, the top 5 holdings are Apple Inc (AAPL), Bank of America Corp (BAC), American Express Co (AXP), Coca-Cola Co (KO), Chevron Corp (CVX), not including call and put options.

What is the ideal portfolio mix? ›

If you are a moderate-risk investor, it's best to start with a 60-30-10 or 70-20-10 allocation. Those of you who have a 60-40 allocation can also add a touch of gold to their portfolios for better diversification. If you are conservative, then 50-40-10 or 50-30-20 is a good way to start off on your investment journey.

How to diversify portfolio in 2024? ›

How to diversify your portfolio: 8 strategies
  1. Understand asset classes. ...
  2. Diversify by asset class. ...
  3. Diversify within asset classes. ...
  4. Invest in an ETF. ...
  5. Consider fixed-income investments. ...
  6. Follow a buy-hold strategy. ...
  7. Keep investing over time. ...
  8. Regularly rebalance your portfolio.
Apr 15, 2024

How do you know if a portfolio is well-diversified? ›

A well-diversified portfolio invests in many different asset classes. It has a relatively low allocation to any single security. Because of that, if one security significantly underperforms, it won't have a meaningful impact on the portfolio's overall return.

How many funds should be in a diversified portfolio? ›

How many funds are enough? One thing you should always remember is that a lot of funds in your portfolio doesn't mean you have a diversified portfolio. A portfolio with 15 funds that have overlapping is not diversified. You should have no more than 4 funds in your portfolio.

Why not invest everything in the S&P 500? ›

Lack of Global Diversification

The S&P 500 is all US-domiciled companies that over the last ~40 years have accounted for ~50% of all global stocks. By just owning the S&P 500 you miss out on almost half of the global opportunity set which is another ~10,000 public companies.

Which stock is riskiest to a diversified investor? ›

Which stock is riskier for a diversified investor? For diversified investors the relevant risk is measured by beta. Therefore, the stock with the higher beta is more risky.

What are the major four 4 assets of an investors portfolio? ›

In finance, asset class is often used to describe a group of investments that are similar and are subject to the same regulations. There are four main asset classes – cash, fixed income, equities, and property – and it's likely your portfolio covers all four areas even if you're not familiar with the term.

What are the four key elements of investment? ›

  • Goals. Create clear, appropriate investment goals. An investment goal is essentially any plan investors have for their money. ...
  • Balance. Keep a balanced and diversified mix of investments. ...
  • Cost. Minimize costs. ...
  • Discipline. Maintain perspective and long-term discipline.

What are the key elements of a portfolio? ›

Key elements of a portfolio include a cover letter, table of contents, entries of core and optional student work, dates, drafts, and reflections. Portfolio assessment aims to provide a holistic view of student abilities through authentic artifacts and promotes student ownership over learning goals.

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