Investing Explained: How to Diversify Your Portfolio
Diversification is an important cornerstone of investing. Owning many different assets can reduce risk and help you on the path to financial success. But you can’t just shove money into any asset and hope it works out. Proper diversification requires some research — and a little portfolio maintenance.
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What is portfolio diversification?
Diversification is an investing strategy that involves spreading your money across assets. Basically, it’s the opposite of putting all your eggs into one basket.
Diversified portfolios aim to invest in a mix of assets, each of which may respond in different ways to market events. (Such as recessions, interest rate changes, etc.) Buying assets that move in distinct ways can decrease the odds your portfolio will lose its value overnight. The end goal: a smoother investment journey with fewer risks and smaller bumps.
How risk tolerance factors in
Risk tolerance describes your financial and emotional ability to withstand losses.
If you have a low risk tolerance, you may prefer lower-risk assets like cash, bonds, or blue-chip stocks. Investors with a high risk tolerance may invest in more aggressive assets. These could include growth stocks, real estate, or cryptocurrencies, to name a few.
Determining your risk tolerance can help you identify assets that will — or won’t! — suit your needs. From there, you can start diversifying based on your ideal risk-reward balance.
Benefits of diversifying your portfolio
Diversifying your portfolio doesn’t guarantee gains. The benefits it does provide, however, can help you stay on track to meet your goals.
Spreading the risk
Spreading your money across multiple assets, by definition, means your money isn’t sitting in one place. That way, you guard against the risk of losing all your money on a single investment.
Stabilizing the peaks and valleys
Owning many assets, especially assets with low correlation — meaning they don’t have any particular tendency to move up or down together — can boost your portfolio’s resilience.
Ideally, your assets won’t all respond the same way to market events. When one asset or industry tanks, another may stay steady or even gain value.
In this way, diversification can smooth out the natural “peaks” and “valleys” of investing.
Better long-term performance
Diversification doesn’t prevent all losses all the time. However, spreading your money around means you might lose less during market downturns. You may also recover faster when the market swings back up.
As a result, diversification can lead to better long-term portfolio performance. That means a bigger nest egg for you when it’s time to start cashing in!
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Common types of diversification
There’s no single “right” way to diversify your portfolio. It’s a process that involves mixing and matching strategies to find what’s best for you.
Diversifying by asset class
Buying across asset classes is the most obvious way to diversify. Many investors start with a mix of stocks, bonds, and sometimes real estate. You may also consider the potential (and risks) that “alternative assets” like commodities and cryptos bring to the table.
Cash is an important, often overlooked diversification tool. While not “invested” in the same way, stashing cash in a high-yield savings account or CDs:
- Reduces the impact of inflation on your savings
- Minimizes the risk that you’ll have to sell investments to pay for emergencies
- Ensures you have liquid funds available if investment opportunities arise
Diversifying by sector
It’s not enough to diversify across assets; you should also diversify within assets.
One method is to buy assets from different sectors, like tech, energy, and finance. Doing so decreases the risk that bad news in one sector will wipe out your entire portfolio.
Plus, investing across more of the economy means you might capture more gains when multiple sectors do well.
Diversifying by location
Investing across borders injects unique diversity into a portfolio.
International markets often offer assets with unique political, economic, and business exposures. These may move in different ways, or at different speeds, than US-based assets. Buying across borders can expose you to potential upsides in other economies while offering some protection against negative events in the “home” market.
However, you’ll want to consider carefully! Every investment and market comes with its own political and economic risks that may or may not suit your tolerance.
Diversifying across market capitalization
Market capitalization describes a company’s size based on the total value of its stocks. Companies tend to face unique benefits and risks based on their size. For example, large-cap stocks tend to be relatively stable. However, they often grow slower than riskier small-cap stocks. Investing across different-sized companies can help you balance short- and long-term growth and risk.
Diversifying across investment styles
An investment’s “style” describes the type of investment. For instance, growth stocks are often expected to grow fast. Dividend stocks boost your income potential by paying regular dividends. Buying into different styles allows you to customize your potential mix of growth, income, and risk.
Practical steps to diversify your portfolio
It takes time and research to identify the right assets for diversification. Here’s where to start.
Diversification for beginners
One of the easiest ways to diversify, especially for beginners, is by buying funds. These may include exchange-traded funds (ETFs), mutual funds, and/or index funds.
In each case, these funds buy a bunch of assets. Then the fund sells its own shares, with each share containing a slice of every asset within the fund. So, buying one share in an ETF means you immediately own a tiny piece of dozens or hundreds of other assets.
The exact assets a fund buys depend on its stated goals. For instance, an ESG ETF may focus on environmentally friendly stocks. An income mutual fund may focus on bonds and dividend stocks. And index funds buy the assets listed in their stated index, like the S&P 500.
Do a little research to find the fund(s) that fit your needs and wants. Aside from asset mix, you’ll also want to consider each fund’s:
- Fees
- Investment minimums
- And tax implications
Assessing current investments
Before buying into any fund or asset, consider your current investments. Ask yourself:
- Am I too cash-heavy, stock-heavy, or bond-heavy for my situation and goals? Where could I stand to invest a little less — or a little more?
- Am I too concentrated in a single sector?
- Does my portfolio’s risk level match my risk tolerance?
- Should I add exposure to international markets?
In other words: Find out where you are now before you decide where you should go.
Identifying new investment opportunities
Next, it’s time to start looking for specific investment opportunities. Consider how various assets, asset classes, sectors, or countries could fit your needs, goals, and risk tolerance.
For instance, if you’re holding all cash, you might start with stocks. From there, you might decide you want both growth and dividend-paying stocks in the energy and finance sectors. Then, you can narrow it down to specific companies that suit your needs.
Or, you can take an easier route and buy shares in one or more funds that achieve this diversification for you. (Such as a growth stock fund, a dividend-paying fund, an S&P 500 index fund, etc.)
Over-diversification: What to avoid
Diversification is about spreading your eggs to different baskets. But you don’t want to put your eggs into so many baskets that you can’t profit!
Over-diversification can happen when you buy too many assets or asset classes to see real gains. For an extreme example, say you put $1 each into 5,000 different assets. If only one asset increases in value, you don’t see much profit. But if you put $100 each into 50 assets, you’ll see bigger profits when one asset gains. (Especially over time!)
You’ll also want to watch for overlapping fund investments. For instance, a large-cap ETF and an S&P 500 index fund will probably own a lot of the same companies. Before buying in, double-check each fund’s “menu” for identical names.
Rebalancing your portfolio
Even a diversified portfolio isn’t a “set it and forget it” affair. Be sure to check in regularly to make sure you’re staying on track. If you’re veering off-path, it’s time to rebalance.
When and how to rebalance
Ideally, you should check on your portfolio quarterly or at least semi-annually. This provides you a chance to buy and sell assets to keep your portfolio aligned with your goals. You may need to rebalance when:
- Your portfolio “drifts” off course. This happens when an asset or industry under- or over-performs the rest of your portfolio. As asset values go up and down, you may become under- or over-invested in an area.
- Your needs or goals change. Your mix of stocks, bonds, and other assets should reflect where you are and where you want to go. When life throws you a curveball, your portfolio may need to “curve” to match your new trajectory.
- You age into a lower risk tolerance. Generally, as you get closer to your goals, it’s wise to start moving into lower-risk assets to prevent losing your nest egg. Otherwise, you might lose all your hard-earned money with no time to recover.
When it’s time to rebalance, simply contact your broker and inform them which assets you’d like to buy or sell.
Diversification is important — not impossible
Diversification sounds like a tall order at first. But with a little research and time, you can build a more resilient portfolio designed to weather the market’s ups and downs.
Unlocking the benefits of diversification can help you manage risk, build long-term wealth, and achieve the retirement of your dreams.
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About the Author

Anna Yen
Anna Yen, CFA, is Senior Advisor for Prudent Investors, a registered investment advisor for fiduciaries of trusts, estates, conservatorships/guardianships, and families. Over the last 20+ years, she’s held senior roles at UBS, JPMorgan, and asset management firms, along with founding personal finance blog Family Money Map and bilingual storytelling podcast Chinese Star Tales. Anna also serves on the Board of Directors for the Down Syndrome Diagnosis Network. She graduated with economics and computer science degrees from the Wharton School and Penn Engineering at the University of Pennsylvania. Anna’s worked in 5 countries and visited 57.