The importance of diversifying your portfolio
You’ve likely heard the old adage: Don’t put all your eggs in one basket. That saying also holds true when it comes to investing.
Diversification is a strategy in which investors divide their money into a mix of different investments. A diversified portfolio is generally less risky than putting all of your money into one single type of investment and can help generate stronger long-term returns.
Diversification means different things to different investors. One investor might think that owning a mutual fund that holds a basket of stocks offers ample diversification. Another investor might think a laddered guaranteed investment certificate (GIC) strategy provides adequate diversification because the GICs mature at different times, allowing the investor to take advantage of changing interest rates.
However, most investment professionals would tell you that proper diversification requires a lot more thought and work. That’s because there are a wide variety of ways to diversify your portfolio, as well as many reasons to do so. Here are three of the most common ways to diversify:
1. Lower your volatility
Spreading out your investments across geographic regions, sectors and asset classes (like stocks, bonds and cash) can help lower your overall exposure to market volatility and smooth out your returns. That’s because when one sector, region or asset class is out of favour or falling in value, others may continue to perform well.
2. Reduce home country bias/sector focus
It’s understandable that many Canadians prefer to invest in Canadian companies. That’s because we know these companies well, buy and use their products or services, and may even know people who work there.
However, Canada’s investment market is heavily weighted in three sectors: financials, energy and materials. Your portfolio may benefit if those three sectors go up in value. But you’ll experience the opposite if these areas of the market weaken. Conversely, there are a number of high-growth sectors – including health care and information technology – that are under-represented in the Canadian equity market.
Our country is a great place to invest. But consider this: Canada represents only 3% of the world's investible universe. Put another way, 97% of all investment opportunities lie beyond our borders.1
3. Take advantage of different investment styles
Another popular way to diversify your portfolio is by investment style. There are a number of investments styles, but the two most popular are value and growth.
A value manager tends to consider, among other things, the fundamental strength of a company and its management team, and whether that company’s stock price is undervalued based on estimates of its true worth. A growth manager doesn’t necessarily take into consideration the price of the company’s stock. Instead, it considers how fast the company has been growing and whether new products or other competitive advantages should accelerate earnings in the future, which would likely benefit the stock price.
Different investment styles tend to perform differently at certain points in an economic cycle. Therefore, having a portfolio that includes different investment styles can help smooth out your returns over the long term.
Your financial advisor can help you diversify your portfolio by choosing the right mix of investments to reach your long-term investment goals.
1 Source: Bloomberg L.P., Standard and Poor’s, MSCI, data as at July 31, 2016. Canada is represented by S&P/TSX Composite Index and world is represented by MSCI All Country World Index.
The contents of this piece are not to be used or construed as investment advice or as an endorsement or recommendation of any entity or security discussed.