No matter how you invest, certain principles are important to maintain the boundaries of risk exposure and the return of your portfolio. Diversification is one of these principles.
During strong market times, the importance of diversification may be overlooked as we focus on securities or sectors that have outperformed. However, comparing portfolios to this performance is not a prudent exercise as a well-diversified portfolio is not meant to generate the highest returns.
Diversification is put in place to help protect a portfolio from unsystematic risks, such as those that may affect a specific security or industry. By having a mix of different investments, such as across industries, sectors, geographies or even asset types, the positive performance of some investments has the potential to offset the negative performance of others, which may help minimize the portfolio’s downside.
In order for diversification to work to your benefit, rebalancing a portfolio on a regular basis is important. Perhaps recent market gains have led one security to dominate the portfolio. Or, over time a portfolio’s asset mix may become unbalanced. What mix is appropriate? This depends on personal circumstances and should be established as part of your overall wealth plan.
Diversification remains an important element of portfolio construction. Having these principles, and consistently following them, is an important element of risk control that has been put in place to support your investment success.