Investing comes inherently with risk and there’s no avoiding it. But one way people mitigate and manage this risk is to diversify. What is it, why is it important and how can you do it? We answer all that in the article below.
What is risk in investing?
All trading and investing is essentially a game of risk and reward. What does that mean? Well, it’s the balancing act that is your chances of making money and your chances of losing money – both of which can happen at any point.
Risk underpins every trade and investment decision. The general rule on risk vs reward goes as follows: the higher the risk, the larger the potential reward you could stand to gain and vice versa. So, there’s no chance of making healthy returns without taking some sort of risk here and there, but it shouldn’t be too dominated by one side. That’s where diversification comes into play.
What is diversification and why is it important?
Diversification is the process of spreading your risk (investments) across multiple assets, markets and investment channels. This could mean investing part of your portfolio into stock trading, forex, commodities, crypto and index funds, as well as other options such as property with a variety of risk levels.
This spreads the risk associated with your investments, making your portfolio more buoyant in times of crisis or during market downturns. It’s the trading version of the “don’t leave all your eggs in one basket” metaphor – essentially helping you to avoid significant losses if one investment is impacted dramatically. Portfolio diversification is a strategy used by most investors and funds to manage risk.
How can investors diversify?
To diversify, you’ll need to select a few different investment options and divide your assets between them as you see fit. Depending on your tolerance for risk, you can invest more or less in higher-risk options such as stocks, shares and crypto or lower-risk options such as property, bonds and index funds.
You can also diversify within specific markets, for example, choosing a variety of lower and higher-risk stock options or forex currency pairings. You may have to juggle various accounts and investing platforms to diversify successfully, although some offer multi-asset trading on single platforms.
Once your investments are in place, you’ll need to keep a close eye on them to manage your positions and capitalise on the little (or big) wins. For the more active investors, this can be thrilling, but others may prefer to leave it to a professional trader or fund manager.
