1. Invest long term

Diversifying your investments

Long-term investing requires a serious commitment, and you’ll probably want to minimize risks along the way. Perhaps the biggest risk of all is losing money on your investments. So how do you deal with that? For starters, just heed the age-old advice of not putting all your eggs in one basket, a practice called diversification. We put together this brief guide to show you what diversification is, how to go about it, and how it can benefit you.

What is portfolio diversification?

Portfolio diversification is the practice of assembling an investment portfolio consisting of a wide variety of assets and asset types, preferably across multiple markets, in an attempt to reduce risks.
The main idea behind diversification is to limit your exposure to a single asset or market, so that the value of your portfolio can potentially keep growing even if one or more of its elements are suffering losses.
Benefits of diversification
  • Diluting risk: If one of your investments is performing especially poorly, others will balance it out and your overall position won’t be affected that much
  • Saving you time in the long term: If you have a well-diversified portfolio, you won’t need to adjust it often in reaction to market turbulence
  • Pleasant surprises: If you invest in a wide range of companies and sectors, you’re more likely to stumble upon some unexpected winners
Disadvantages of diversification
  • Diluting gains: Diversification cuts both ways; if there’s one outstanding performer in your portfolio, your overall gains may still be modest
  • Needs research: Assembling a diversified equity portfolio - even if mostly via ETFs - may require significant time and effort at the beginning
  • Costs: Buying many stocks and other assets can multiply your trading costs

Diversification strategies

There are several approaches to diversification. In most cases, rather than hoarding lots of random stocks and other assets, try to pick investments that complement one another; so that whenever one goes down, the other is likely to go up.
Diversification by asset type
The most obvious form of diversification is spreading your investments across various asset types. Bonds or commodities may rise when stocks are down, or vice versa.
Diversification by market
We may be living in an interconnected global economy that lifts all boats equally, but it still makes sense to divide your investments across several markets. Emerging markets may be soaring when European stocks are stagnating; or the US market may be a safe haven in the event of an emerging-market crisis.
Diversification by sector
Even if you stick to equities only, it is a good idea to invest across many sectors. Retail or utility stocks may be boring, but you’ll appreciate their small but steady gains when your favorite tech startup stocks take a hit. If possible, try to invest in complementary stocks - for example, investing in a sunscreen maker and a raincoat manufacturer at the same time will probably protect you from losses no matter what the weather is like.
Dollar cost averaging
This is a special strategy that allows you to deal with price volatility in a single stock. For example, rather than buying 10 shares of stock ‘X’ every month, try to buy $100 worth of stock ‘X’ every month. This way, you’ll buy more of the stock when the price is low (therefore potential gains are bigger), and fewer of the stock when the price is high.
You don’t have the time or knowledge to put together a portfolio on your own? Don’t worry - there are some asset classes that were created with investors like you in mind. The best known of these are ETFs (exchange-traded funds) and mutual funds, which we’ll discuss below.
  • ETFs: ETFs consist of a broad portfolio of shares, usually replicating a market index. If you buy an ETF, what happens is you basically invest in all those underlying shares at the same time. In essence, the ETF does the diversification for you, so you don’t need to worry about picking the right individual stocks yourself.
    For example, an S&P 500 ETF invests in the exact same 500 stocks that make up the S&P 500 index, in the exact same proportions. If you believe in the long-term potential of the US stock market and the heavyweights of the US economy, all you may ever need to do is keep buying S&P 500 ETFs.
    While you do that, though, keep in mind that it is also worth exploring other asset types and other markets. The good news is that there’s probably an ETF for virtually every sub-market and niche market index out there. An ETF for European banks, US telcos, Asian small caps, global pharma, or oil and gas? The biggest ETF providers will have you covered.
    Are you ready to explore ETFs? Start with our selection of the best ETF brokers in your region. Most of these brokers offer hundreds of ETFs to choose from.
  • Funds: Like ETFs, mutual funds invest in a diverse portfolio of many underlying shares, taking the burden of diversification off your shoulders. The biggest difference is that while ETFs simply automatically follow an index more or less without human intervention, mutual funds are actively managed. This means that a team of expert analysts, portfolio managers and traders continuously adjust the composition of the fund, with an eye on optimizing gains while keeping risks under control.
    Because mutual funds are actively managed, they usually involve higher fees. Also, compared with most ETFs, mutual funds tend to be more focused and invest in fewer stocks. However, they still provide a diversified portfolio; probably a much better one than most beginner investors would be able to compile on their own. Want to see for yourself? Check out the best brokers for funds available in your area.
  • Fractional shares: Despite the availability of convenient instruments such as ETFs or equity funds, you may still decide to go it alone and hand-pick stocks for your own diversified equity portfolio. For example, you can do this by looking at a stock index such as the S&P 500 or the NASDAQ and investing in some of its biggest or best-known components; or by choosing stocks or industries that you’re closely familiar with.
    One problem you may soon run into is that the amount you want to invest - maybe as low as $100 at a time - won’t buy you too many shares, or even a single one. Thankfully, an increasing number of brokers now offer fractional shares - that is, the opportunity to buy just a small piece of an otherwise expensive stock.
    In practice, this means that for your $100, you may easily buy 10 different stocks for $10 apiece, rather than for their full price (which can often be $200-$300 for some of the most popular US stocks).

Diversification - an example

Putting together your own stock portfolio versus buying ETFs/funds both have their advantages and disadvantages. However, most retail investors likely won’t be able to compile a portfolio that consistently outperforms the wider market. The biggest risk is picking the wrong stocks. The table here shows the performance of the NASDAQ index (easily available in the form of an ETF) versus a few randomly selected stocks that are part of the index.

Other types of diversification

  • Is using multiple brokerages a form of diversification?
    Signing up to multiple brokerages is not typically seen as a form of diversification, but it can in fact lower your risk. Many of the world’s top regulators offer some form of investor protection in case a broker defaults; and by keeping your investments at more than one broker, you can multiply the protection available to you.
    Let’s say your broker’s regulator offers investor protection of up to $20,000 in the event of broker bankruptcy. If you have $40,000 to invest, it may be a good idea to split this amount between two brokers, so that if one (or both) go bankrupt, you can still recover all your investment.
    Another reason to diversify your investments among multiple brokers is that very few brokers offer a full palette of global stocks, ETFs, mutual funds and other assets. If, for example, you want access to a full selection of US stocks and UK bonds, you may have to sign up to two different brokers to get everything you want.
  • Alternatives beyond stock exchanges and broker accounts
    Online brokerage accounts are among the most convenient places to store and grow your savings, but diversification doesn’t need to stop there. Depending on your financial means and investment goals, you can keep part of your savings in a bank account, in the form of physical assets such as gold or artwork, or in real estate.

How to diversify your investments at your broker

ETFs
So you’re looking to diversify your investments by buying ETFs? Great! However, note that not all brokers offer ETFs, and there can also be differences in the number of ETFs offered and in trading costs. Check below if the broker you’re currently using - or considering using - offers ETFs, and under what conditions.
Fractional shares
Fractional shares are a great diversification tool, and they are an increasingly common and popular option at many online brokers. However, not all brokers offer them yet. See below if your current broker or the one you’re considering using offers fractional shares, and under what conditions.
Invest in US stocks
Companies traded on the US stock market are among the most widely known and most valuable ones in the world, so they should have a place in every investor’s portfolio. The US stock market is known for its stability, history of strong long-term performance and well-regulated environment, reducing investment risks. Check the brokers below to find out which of them offer easy and low-cost access to US stocks.
Invest in emerging markets: Mexico
A good way to diversify your investments is to buy stocks on markets in different geographic regions. Emerging markets are an excellent option: you can reduce your overall investment risk as these markets tend correlate less with developed markets like the United States and Europe. Thus, if one market experiences a downturn, your investments in other markets may not be affected as much. Mexico is a prime example of an attractive emerging market – check below to see which brokers offers trading in Mexican stocks and at what conditions.

FAQ

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