Portfolio Diversification: Strategies, Benefits & Examples

Some investors may suffer from "home-country bias" when choosing investments — for example, buying shares in companies they know that operate in their own nation. That can leave investors vulnerable to localized economic downturns, currency devaluations and political risk in their own country. It can also limit choice. The Canadian market, for example, has a higher concentration of energy and financial stocks than many other countries. Canada also accounts for less than 5% of the global investible universe, which means you may miss out on some good businesses by only investing in Canadian firms. To reduce concentration risks, some investors may consider owning stocks and bonds from regions around the world.

TAKE NOTE

Canada represents less than 5% of the global investable market. Investors who only buy Canadian stocks could miss exposure to major industries and companies around the world.

Companies in certain industries may outperform those in industries facing different economic conditions or stages of the business cycle. As an example, a sector that uses a lot of leverage or borrowing to invest, such as real estate, could benefit when interest rates are low, but suffer as rates rise. Having exposure to several major sectors could reduce the impact of a single sector pulling down a portfolio.

Some do-it-yourself investors may adopt styles or methodologies to help them select the stocks they want to own. For example, growth investors screen for companies whose revenues or earnings are trending higher. Value investors, by comparison, seek out stocks that appear to be selling at a lower price than their peers by various valuation metrics. Though these and other styles can be effective at boosting returns, certain styles may outperform others at any one time, a reason why some investors employ more than one in managing your portfolio.

How you diversify your portfolio may depend on factors such as your financial goals, investing timeline, and comfort with risk. Investors with longer time horizons may choose to hold more growth-oriented investments, such as stocks, because they may have more time to recover from short-term market declines.

As investors get closer to needing their money, they may shift toward more conservative investments, such as bonds or cash investments, to help reduce volatility and preserve capital.

Some investors may consider investing in so-called alternative asset classes, that have the potential to hold or increase their value when mainstream securities tank. Some of these assets could include an investment property, precious metals or cryptocurrency. Some alternative assets may appeal more broadly to middle- and high-income investors who already have substantial stock and bond holdings. This can be true in the case of more sophisticated classes like private equity and hedge funds, which can require minimum investments and require you to lock in your funds. 

Exposure to a wide range of assets can increase the likelihood you will benefit from the unpredictable outperformance of any one investment or set of investments. For example, if U.S. tech stocks post big gains, you could benefit. Conversely, if long-term bonds rebound, you’ll also benefit.

The fluctuation of asset values can be psychologically painful to many investors and financially harmful to those who need to draw down their holdings, such as retirees. Diversification can help to smooth out the markets’ roughest edges.

By holding a mix of investments for short-medium- and long-term purposes, it could help to ensure you have assets that can be sold, if necessary, on short notice. Longer-term holdings may sacrifice liquidity in return for either guaranteed or higher potential returns.

A diversified portfolio can be designed to suit all kinds of goals — from providing income in retirement income to funding a child’s wedding — while remaining sensitive to your financial personality and risk tolerance.

Here are some tasks involved in building and maintaining a diversified portfolio.

Diversification works best when your investments don’t all react the same way to market events. For example, a portfolio invested entirely in stocks may be more vulnerable during a market downturn. Adding investments such as bonds, GICs, or cash products may help reduce overall portfolio risk and volatility.

Because different investments perform differently over time, your portfolio can gradually drift away from your original investment mix. For example, if your goal is to maintain a 50/50 split between stocks and bonds, a strong stock market year could leave you more heavily weighted toward stocks than intended.

Regularly reviewing and rebalancing your portfolio (often once or twice a year) can help keep your investments aligned with your goals and risk tolerance. This may involve adjusting your holdings over time to help keep your portfolio aligned with your investment plan and comfort with risk.

You never know how your investments may perform in the future, but you can foresee how much of your returns will be offset by trading and portfolio management fees. Tracking and, where possible, keeping your costs low, can optimize your gains over time.

Your investment mix should match its ultimate purpose. A post-secondary education savings plan, for example, might typically become more conservative as your child approaches high school graduation.

You can enhance the potential for returns or reduce risk with tactical changes to a portfolio. Some investors review their allocation following major market declines, though predicting recoveries is difficult and changes should be considered carefully. It may also be prudent to hold bonds when interest rates appear set to fall. Timing the markets is notoriously difficult, however, which another reason to hold multiple asset classes at once, making adjustments as you see fit.

You may be aware of “balanced” mutual funds and “asset allocation” Exchange-Traded Funds (ETFs) that hold Canadian, U.S. and international stocks as well as bonds in a single package. These investments may offer a pre-set package of investments that is regularly rebalanced — either passively or actively on your behalf, for the cost of a management expense fee. Many of these instruments can be bought by anyone with a brokerage account.

You can think about diversification right from the start. A downturn can happen at any time, so there may be no time like the present to start protecting your portfolio.

One common diversification strategy is to allocate roughly 60% of your portfolio to equities and the other 40% to fixed income. This is often described as a balanced portfolio, combining the long-term returns of stocks with the greater stability of bonds. Depending on your time horizon, investing personality, financial resources and market conditions, you may choose to deviate from that balance or add alternative assets. Over time, your portfolio will naturally drift from your initial mix, requiring you to periodically rebalance your holdings.

The easiest way to diversify is to hold funds invested in a range of stocks and bonds. If you have a brokerage account, you can buy fully diversified, low-cost ETFs, such as TD ETF Portfolios.

Yes. Risk management is a key benefit of diversification.

Yes. Diversification can help to ensure you don’t miss out on the outperformance of any one type of investment. 

Diversification helps ensure part of your portfolio is allocated to liquid investments that can be sold on short notice without incurring losses.

Diversification can help to both preserve your capital and achieve long-term growth.

Diversification can provide exposure to different asset classes, helping to ensure you are not overly exposed to investments that experience larger-than-expected losses, keeping in mind that you would need to reassess and rebalance as required.

Portfolio diversification is one of the most common strategies investors use to help manage risk and navigate changing market conditions. By spreading investments across different asset classes, sectors, and regions, investors can reduce overexposure to any single investment while staying focused on long-term financial goals.

For self-directed investors, diversified investments such as ETFs and mutual funds can help make building a balanced portfolio more accessible. With tools, research, and educational resources available through TD Direct Investing, investors can explore different ways to build and manage a diversified portfolio that aligns with their goals and risk tolerance.