Proper portfolio diversification is the first and foremost principle of sound investing. It is as important as it is straightforward to implement. All that’s needed is a bit of portfolio tracking and occasional portfolio adjustments.
Portfolio diversification: The only free lunch in investing
Nobel prize laureate Harry Markowity once famously called portfolio diversification the only free lunch in investing. The “free lunch” metaphor highlights the unique benefit of diversification: it allows investors to manage risk effectively at no additional cost and without any impact on portfolio returns.
What constitutes good portfolio diversification?
Good investment portfolio diversification means allocating funds across different asset classes, industries, and regions. This involves including a mix of investments such as stocks, bonds, real estate, and alternative assets that behave differently in various market conditions. Diversification requires careful selection to avoid over-concentration in any one area or exposure to similar risks.
The benefits of proper portfolio diversification
By combining assets that react differently to market conditions, such as stocks, bonds, real estate, and alternative investments, a portfolio can achieve more stable overall returns. Diversification also minimizes the impact of a single asset’s poor performance, as gains in other investments can offset potential losses. The key to effective diversification is balancing risk and return while aligning the portfolio with the investor’s financial goals and risk tolerance.
Types of risk addressed by portfolio diversification
In essence, your portfolio is exposed to two types of risk. Idiosyncratic risks, i.e. risk specific to a company or an industry, and market risks.
Idiosyncratic risk
Any company is exposed to a multitude of risks. These can come from the inside, for example from bad management, or from the outside, such as regulatory changes or natural catastrophes. These are a just a few examples of the many risks faced by any company. Against this backdrop, the need to diversify evident. Similarly, at the industry level, industries face risks as well. Structural change is one example. Think of the fate of Kodak cameras that were replaced by smart phones with integrated cameras.
Market risk
Expressed as market volatility, market risk affects all market participants and assets. Drivers are factors such as political conflict, inflation or interest rates. These factors will affect different types of asset classes, industries and even companies in different ways.
How to construct a diversified investment portfolio.
The right formula differs from investor to investor. If you are a risk averse investor, you need to start diversifying from the asset level. You will need to build your portfolio on bonds, large diversified ETFs and large cap stocks. If you are young and prepared to take on a certain degree of risk, you would want to opt of growth stocks. A fast and convenient way to find growth stocks is through our ultra-fast stock screener.
Main diversification categories
There are four principal diversification categories:
1 – Geography
Global brokers, such as Interactive Brokers make it possible for any investor to add geographic diversification to a portfolio. This means that you can own stocks from outside your country or even continent at a very reasonable price thus adding geographic diversification to your portfolio. There are also many ETFs that focus on particular countries or regions.
2 – Asset Class
As mentioned in the introduction, different asset classes come with their distinct risk and return profiles, which investors need to consider for their individual financial situation and degree of expertise. The main asset classes to consider are bonds, stocks, ETFs, gold and increasingly alternative asset classes, such as cryptocurrencies, crowdlending and-funding, or even collectibles. If you think bonds are two complex, you can easily get exposure to bonds via bond ETFs. You can check out our high yield bond ETF portfolio to view some of the best bond ETFs in the market.
3 – Industry
There a dozens of industries to get exposure to. The Ziggma screener gives you access to each and everyone of them. And, even industries themselves can be very heterogeneous. A well-diversified portfolio should be exposed to various, high-growth industries.
4 – Single holding
Unless you invest exclusively in an index ETF, you will want to monitor your individual holdings exposure. No single holding should make up a disproportionate share of the portfolio. As a rough rule of thumb, no stock should make up more than 1/total number of holdings + 10%.
How does portfolio diversification reduce portfolio risk?
Proper portfolio diversification reduces portfolio risk by spreading investments across various asset classes, industries, and regions that do not move in tandem. When some investments decline in value, others may remain stable or even increase, helping to offset potential losses. Diversification takes advantage of the fact that different assets respond differently to economic events, market cycles, and interest rate changes. By minimizing reliance on a single investment or market, diversification lowers the overall volatility of the portfolio. This approach ensures that no single event or trend has a disproportionately large impact on the portfolio’s total performance.
Can a well-diversified portfolio increase returns?
Many academic studies have been carried out on this topic. Researchers have found it hard to reach a consensus because of the infeasibility to draw conclusions across different investment strategies, i.e. portfolios comprising different asset classes.
What is certain is that diversification done right reduces the risk of major losses. This is in line with Warren Buffett’s rule number one “Don’t lose money” and rule number two “Never forget rule number one.”
Ways to gain from sound investment portfolio diversification
Many academic studies show that portfolio diversification done right can generate a series of valuable benefits.
✅ Stable investment return, as gains offset losses
✅ Minimize downside risk in the event of adverse idiosyncratic events affecting a company or industry you have exposure to
✅ Minimize downside risk in the event of adverse market events.
✅ Increase your chances to own winners. By diversifying across a handful to a dozen of growth stocks you increase your chances to own one or several future champions.
How to monitor investment portfolio diversification?
Portfolio monitoring is essential for achieving the expected long-term investment returns, as it ensures your strategy remains aligned with your goals. A critical aspect of this process is keeping a close eye on diversification to maintain a balanced and resilient portfolio. However, regular monitoring can be tedious and time-consuming. Let’s be honest—exploring new investment opportunities often feels far more exciting than the meticulous task of portfolio oversight. Yet, neglecting this responsibility can lead to missed adjustments and increased risk over time.
This is why we help our users monitor diversification in two ways:
Portfolio diversification insights
The Ziggma app provides well-designed charts covering your portfolio diversification by asset class, industry, single stock, top three stocks and geography. In addition, we help users monitor portfolio quality by providing charts on
Portfolio diversification alerts
With a Ziggma Smart Alert, portfolio monitoring just got a whole lot easier—and smarter! All you need to do is set a threshold for maximum exposure to a single company, industry, or asset class, and we’ll handle the rest. Say goodbye to the hassle of constant oversight and hello to more free time for the things you actually enjoy. When your threshold is reached, we’ll send you a quick notification so you can make the necessary adjustments. It’s portfolio management made effortless, leaving you to focus on what matters most.
Beware of portfolio diversification: It’s key to your long-term investing success.
Diversification is the cornerstone of a resilient and successful investment portfolio, but staying on top of it doesn’t have to be complicated. With Ziggma’s innovative tools, like Smart Alerts, you can automate portfolio monitoring and maintain optimal balance with ease. By setting thresholds for exposure, you ensure that your portfolio stays diversified and aligned with your goals, no matter the market conditions. This not only saves you time but also empowers you to focus on exploring new opportunities with confidence. Let Ziggma help you take the guesswork out of portfolio management and make smarter investing simple.