7 Ways to Diversify Your Investments Without Spending a Fortune

Smiling businessman or investor
Jacob Lund / Shutterstock.com

This story originally appeared on The Penny Hoarder.

You know it’s a bad idea to pour your life’s savings into a single investment.

It’s personal finance 101: Invest regularly, and diversify your portfolio. But a lot of times, there isn’t much guidance beyond that.

So as an investor, you’re left wondering: How do you know if your portfolio is diversified? How many investments do you need in a diversified portfolio? How are you supposed to find the time and money for so many investments, especially if you’re a beginning investor?

There are two things you need to know about diversifying your investments:

One, it’s ridiculously difficult, if not impossible, for ordinary investors like you and me to build a diversified portfolio from scratch.

Two, it’s easy for ordinary investors to own a diversified portfolio if you’re willing to take a few shortcuts. Stick around and we’ll discuss those.

The Goal of Diversification

Diversify investment
Vintage Tone / Shutterstock.com

Diversification isn’t just about picking a bunch of great companies to buy stock in. What happens when the stock market crashes?

“If the stock market drops, you wouldn’t want your entire portfolio to drop along with it,” said Taylor Jessee, a certified financial planner and CPA who is director of financial planning at Taylor Hoffman Wealth Management in Richmond, Virginia. “The idea behind diversifying is to play defense.”

But the goal goes beyond risk management.

“In a general sense, it’s about spreading your risks around,” said Jacob Sadler, CFP with Woodstone Financial in Asheville, North Carolina. “Of equal importance, however, is positioning yourself to capture opportunity when and where it occurs.”

In other words, diversification also helps you seize higher returns.

What a Diversified Portfolio Really Looks Like

Diverse portfolio
Florence-Joseph McGinn / Shutterstock.com

Your investment portfolio needs a mix of stocks and bonds. Investing in stocks is where you’ll get the big growth, but it’s also high-risk. Investing in bonds has less earning potential, but bonds add stability to offset stock market risks.

Your ideal asset allocation, e.g., how much of your portfolio is invested in stocks versus bonds, depends on your age, how much time you have until retirement and your risk tolerance.

Sounds simple so far? We’re just getting started. To have a diverse portfolio, you’d need the following.

Stocks in Companies of All Different Sizes

Stock in small companies tends to have the biggest potential for profits, which is why it’s often called growth stock. But growth stock is also risky. Investing in giant corporations offers slow and steady returns but less potential growth.

Government and Corporate Bonds

Government bonds are among the safest investments, but they still have risk. The interest they pay is so low that your investment might not keep up with inflation. Corporate bonds pay significantly higher interest rates, but you could lose the money you invested if the corporation defaults on its debt.

International Stocks and Bonds

Spreading out your investments geographically reduces your risk and also allows you to take advantage of growing markets throughout the world.

A Broad Range of Sectors

Investing in a variety of sectors of the economy — like health care, financial products, real estate and utilities — reduces your risk in case one part of the economy collapses. For example, you’re better protected from a housing bubble collapse or a global pandemic that brings travel and hospitality to a standstill.

Investments That Don’t Move With the Stock Market

To achieve diversification, you don’t want all your investments to rise and fall with the stock market. That’s why you want investments that are stable even when the stock market is volatile — and some that increase in value when the market tanks.

For example, sales at discount stores often rise during recessions and their share prices often increase altogether.

Many investors diversify by going outside the stock and bond markets by buying different asset classes. They might invest in commodities like gold, which usually increase in value during downturns. Or they invest in real estate, which is usually less volatile than investing in stocks.

Now, let’s get to what we promised you: an easy way to build a diversified portfolio that doesn’t require a doctorate in economics. Here’s how to diversify in the simplest way possible.

1. Invest in an ETF That Tracks the Stock Market

A man studies financial data at his computer
NicoElNino / Shutterstock.com

The great thing about both exchange-traded funds (ETFs) and mutual funds is that they let you invest in hundreds or even thousands of companies with a single purchase.

The majority of ETFs and some mutual funds are index funds. That means instead of having humans actively managing the investments, the fund is designed to reflect the makeup of a market index, like the S&P 500, which is itself diversified.

“You don’t necessarily need to own a lot of ETFs or funds to be diversified,” Jessee said. “Owning just one S&P 500 index fund means you have your money invested in the 500 largest companies in the U.S.”

You can go even broader than an S&P fund by buying an index fund that tracks the overall stock market. These are known as total market funds.

Pro tip: ETFs tend to have lower fees than mutual funds because they aren’t actively managed.

2. Add in a Broad Market Bond Fund

Investment growth
CreateJobs51 / Shutterstock.com

Investing in a broad market bond index fund gives you broad exposure to the entire bond market in the same way that a total market fund lets you invest in the entire stock market.

The tricky part is deciding how much to put in the stock fund versus how much to invest in the bond fund. You typically want to invest mostly in stocks when you’re young. Then, you allocate more toward bonds when you can’t afford as much risk. Reviewing your asset allocation once a year with a financial pro is well worth the cost.

3. Follow the 5% Rule for Individual Investments

TTIGallery / Shutterstock.com

It’s actually OK to have a large chunk of your assets in a single fund, provided that the fund is sufficiently diversified. It’s also fine to invest in individual stocks when you’re diversifying — but caution is required.

“For diversification, avoid investing more than 5% of your assets in any one firm, such as your company’s stock, and 20% in any particular industry because unforeseen events can quickly destroy values,” said Jeffrey Barnett, founder, president and chief investment officer at Fintegrity in Tenafly, New Jersey. “However, it is fine to have concentrated holdings of a fund that owns a portfolio of 50 or more securities.”

4. Use Sector Funds to Invest in Specific Industries

Stock investor
Viktoriia Hnatiuk / Shutterstock.com

The key to diversifying your portfolio is to be invested in the overall stock and bond markets. But if you want to invest in a certain type of company, like biotech or telecommunications, consider investing in a sector fund that focuses on that industry.

You’ll get greater diversity than you’d get by picking individual stocks in the same industry. Just be careful not to invest too much in a single sector.

5. Don’t Assume More Is Better

A businessman invests in commercial real estate
ImageFlow / Shutterstock.com

Many investors mistakenly think investing in more funds helps them diversify.

“We see this frequently with investors’ investment selections in their 401(k)s,” said Betty Wang, a Denver-based CFP who is founder and president of BW Financial Planning. “The investor is overwhelmed by the many choices of their 401(k) plan so she decides to contribute 5% to each fund offered.”

But a lot of these funds have the same underlying investments, meaning you aren’t getting more diversification. You can often achieve your goals with a single fund or two.

“Overall portfolio performance is unrelated to the number of funds in a portfolio,” Sadler said. “What matters is the number of underlying stock and bond holdings, their weighting and their characteristics.”

6. Automate Your Investments

Jars of change with plants sprouting.
TZIDO SUN / Shutterstock.com

There’s a way to make portfolio diversification even more brainless, which is to automate things.

One way is by investing in a target-date fund. “[It] automatically invests and diversifies your money according to your age and when you want to retire,” Jessee said. “It is basically a one-stop-shop fund.”

Most 401(k) plans offer these as an option, though you can also invest in one on your own.

If you have a Roth or traditional IRA or a taxable brokerage account, you can automatically diversify by using a robo-adviser. A computer algorithm will create a custom mix of assets based on your age, goals and how much risk you’re willing to take.

7. Try to Pick a Winning Team, Not an MVP

Investing
crazystocker / Shutterstock.com

For investors who dream about picking the winning penny stock that becomes the next Apple or Microsoft, diversification may seem like a boring strategy.

But don’t think of investing as trying to pick the person who becomes MVP. Wang suggests treating your portfolio like a team of players, each of whom has different strengths and weaknesses.

“If one player is having a bad game, the other players can carry the team for a win,” she said. “The more diverse your players are, the more likely your team can be successful in various scenarios where different strengths are needed to win.”

Disclosure: The information you read here is always objective. However, we sometimes receive compensation when you click links within our stories.

Read Next
70% of Older Adults Botch This Basic Retirement Question
70% of Older Adults Botch This Basic Retirement Question

Can you answer this fundamental retirement income question?

These Are the 3 Best Used Cars You Can Buy
These Are the 3 Best Used Cars You Can Buy

These vehicles boast reliability, safety and long-lasting value.

12 Easy Ways To Make Make Money Online Without Leaving Home
12 Easy Ways To Make Make Money Online Without Leaving Home

If you’re hanging around the house a lot these days — and who isn’t? — use your time to make some extra cash.

These 13 States Tax Social Security Income
These 13 States Tax Social Security Income

Uncle Sam is not the only one looking for a piece of your retirement income. Is your state on this list?

Never Buy These 12 Things at a Thrift Store
Never Buy These 12 Things at a Thrift Store

Sometimes a great deal is not worth it — or, even worse, is dangerous.

View this page without ads

Help us produce more money-saving articles and videos by subscribing to a membership.

Get Started

Most Popular
7 Kirkland Signature Items to Avoid at Costco
7 Kirkland Signature Items to Avoid at Costco

Even if it seems you save a bundle buying Costco’s Kirkland Signature brand products, they may not be the bargain they appear to be.

If You Find This Thrift Shopping, Buy It
If You Find This Thrift Shopping, Buy It

Whether you resell it for a big profit or add it to your own wardrobe, this type of clothing is a hidden steal.

3 Ways to Get Microsoft Office for Free
3 Ways to Get Microsoft Office for Free

With a little ingenuity, you can cut Office costs to zero.

9 Things You’ll Never See at Costco Again
9 Things You’ll Never See at Costco Again

The warehouse store offers an enormous selection, but these products aren’t coming back.

This Surprise Factor Can Raise Your Risk of Dementia
This Surprise Factor Can Raise Your Risk of Dementia

Nearly half of U.S. residents may face this threat.

Organize Your Home With These 10 Thrift Store Finds
Organize Your Home With These 10 Thrift Store Finds

Resolve to be clutter-free in 2021 with these secondhand purchases.

11 Laws You Could Be Breaking Without Knowing It
11 Laws You Could Be Breaking Without Knowing It

Seriously? Fibbing about the weather is a crime? This and other little-known legal traps await the unwary.

Is This Treatable Condition Causing Your High Blood Pressure?
Is This Treatable Condition Causing Your High Blood Pressure?

Researchers say too many doctors are overlooking this potential source of hypertension.

13 Things Seniors Can Get for Free — or Almost Free
13 Things Seniors Can Get for Free — or Almost Free

There are many ways to get cheap or free services and goods after reaching a certain age.

Taking a Multivitamin? Here’s Why You Should Reconsider
Taking a Multivitamin? Here’s Why You Should Reconsider

A new study has bad news for the millions of Americans who spend money on multivitamins.

21 Items to Cut From Your Budget That You Won’t Even Miss
21 Items to Cut From Your Budget That You Won’t Even Miss

Start off the new year by implementing these small-but-smart savings strategies. They’ll soon add up.

Internet Providers Can’t Charge You for This Anymore
Internet Providers Can’t Charge You for This Anymore

Starting this month, your ISP no longer can bill you for this fee.

15 Painless Ways You Can Cut Costs in 2021
15 Painless Ways You Can Cut Costs in 2021

Follow these tips to save, so you’ll have money for things that really matter.

9 Small Expenses That Are Bleeding Your Budget Dry
9 Small Expenses That Are Bleeding Your Budget Dry

Keep more of future paychecks by eliminating these budget-busting unnecessary expenses.

5 States Lowering Taxes This Year — and 2 Raising Them
5 States Lowering Taxes This Year — and 2 Raising Them

State personal income tax rates, brackets and deductions just changed in these places.

11 Huge Retirement Costs That Are Often Overlooked
11 Huge Retirement Costs That Are Often Overlooked

Does your retirement budget account for all of these costs?

7 Tricks to Cleaning Your Bathroom Faster
7 Tricks to Cleaning Your Bathroom Faster

These tips can get your bathroom sparkling with little time and no elbow grease.

20 Amazon Purchases We Loved in 2020
20 Amazon Purchases We Loved in 2020

These practical products made everyday life a little easier last year — and will do so in the new year, too.

The 10 Golden Rules of Becoming a Millionaire
The 10 Golden Rules of Becoming a Millionaire

I’m a millionaire several times over. I got here the same way you can — by following these simple steps.

View More Articles

View this page without ads

Help us produce more money-saving articles and videos by subscribing to a membership.

Get Started

Add a Comment

Our Policy: We welcome relevant and respectful comments in order to foster healthy and informative discussions. All other comments may be removed. Comments with links are automatically held for moderation.