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Discover practical steps to build a resilient investment strategy through portfolio diversification.

5 Steps to Diversify Your Portfolio

Disclaimer: This website and its content are for informational purposes only and is not financial advice.

Understand Risk Tolerance and Goals

The first fundamental step towards achieving robust portfolio diversification is understanding your risk tolerance and investment goals. Are you a young investor with a long time horizon, comfortable with potential market fluctuations for the possibility of higher growth?

Or are you closer to retirement, prioritizing capital preservation and a steady income stream? Your individual circumstances will significantly influence the types of assets and the level of diversification that is appropriate for you.

Take some time to honestly assess your comfort level with risk and clearly define what you hope to achieve with your investments, whether it's saving for retirement, a down payment on a house, or another significant financial milestone.

This self-assessment forms the bedrock upon which your diversification strategy will be built.

Exploring Different Asset Classes

Once you have a clear understanding of your risk tolerance and goals, the second step in portfolio diversification is to explore different asset classes.

The main asset classes include stocks (representing ownership in companies), bonds (representing loans to governments or corporations), and cash equivalents (highly liquid and low-risk assets like money market accounts).

However, diversification can extend beyond these traditional categories to include real estate, commodities (like gold or oil), and even alternative investments like private equity or hedge funds, although these may come with higher complexity and risk.

The key is to understand the characteristics of each asset class, how they typically perform under different economic conditions, and how they might complement each other within your overall portfolio.

For instance, stocks tend to offer higher growth potential but also come with greater volatility, while bonds are generally less volatile but may offer lower returns.

Diversifying Within Asset Classes

The third crucial step in achieving effective portfolio diversification is to diversify within each asset class. Simply owning a few different stocks isn't enough.

Within the stock market, consider investing in companies of different sizes (large-cap, mid-cap, small-cap), across various sectors (technology, healthcare, energy, consumer staples), and even in international markets.

Similarly, within the bond market, you can diversify by investing in bonds with different maturity dates (short-term, medium-term, long-term) and different credit qualities (government bonds, corporate bonds).

This intra-asset class diversification helps to mitigate the risk associated with any single company, industry, or bond issuer underperforming.

Updated May 18th, 2025

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Review and Rebalance Your Portfolio

The fourth step in your journey toward a well-diversified portfolio involves regularly reviewing and rebalancing your holdings. Over time, the performance of different asset classes will vary, causing your initial asset allocation to drift away from your target.

For example, if the stock market performs exceptionally well, your portfolio might become overweight in stocks, potentially increasing your overall risk.

Rebalancing involves selling some of the over-performing assets and buying more of the underperforming ones to bring your portfolio back in line with your original asset allocation strategy.

This disciplined approach helps to ensure that your portfolio remains aligned with your risk tolerance and investment goals.

Considering Professional Guidance

Finally, the fifth step to successful portfolio diversification is to consider the role of professional guidance. While it's certainly possible to build and manage a diversified portfolio on your own, a financial advisor can provide valuable expertise and personalized recommendations tailored to your specific circumstances.

They can help you assess your risk tolerance, define your investment goals, select appropriate asset classes and investments, and develop a long-term diversification strategy.

Whether you choose to work with a financial advisor or manage your portfolio independently, the principle of portfolio diversification remains a cornerstone of prudent investment management, helping you navigate market uncertainties and work towards your financial aspirations with greater confidence.

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By Jordan McCaleb, Investment Researcher