What is diversification?
Guide Summary
- Diversification spreads your investments across different assets and sectors to reduce overall risk.
- A well-diversified portfolio could smooth out performance and help protect you against downturns in specific markets.
- Too much diversification can limit short-term gains and be harder to manage, so balance is key.
Understanding the importance of diversification
Markets can move unpredictably. One asset class might be soaring while another is falling. Diversification ensures you’re not overly reliant on a single investment or sector to meet your financial goals.
For example, if your portfolio is made up entirely of tech stocks, a downturn in the tech industry could cause a sharp drop in your portfolio. But if you also own bonds, commodities, and shares in other industries, those assets may hold steady or even rise, helping cushion the blow.
Diversification doesn’t guarantee profits, but it can make the investing journey less bumpy by balancing the ups and downs.
Diversification strategies in investing
There are many ways to diversify a portfolio. Investors often combine several of the following approaches:
- Asset classes — such as stocks, bonds, real estate, commodities, or cash equivalents.
- Industries and sectors — spreading across technology, healthcare, finance, consumer goods, and more.
- Market capitalisations — investing in both large, stable companies (blue chips) and smaller, growth-focused firms.
- Risk profiles — mixing higher-risk, higher-return assets with safer, lower-yield options.
- Tangibility — balancing between traditional financial assets and physical assets like property or gold.
The right mix depends on your goals, time horizon, and risk tolerance.
Advantages of diversification
- Could reduce the risk of heavy losses from one sector.
- Could provide protection against market fluctuations.
- Could help investors achieve steadier long-term growth.
- Offers exposure to different markets and opportunities.
Disadvantages of diversification
- Can limit short-term gains if one area performs very well.
- More complex and time-consuming to manage.
- May involve higher costs or fees, especially if spread out across platforms.
- Can feel overwhelming for new investors looking for a simpler approach.
How to assess portfolio diversification
Holding several different investments doesn’t guarantee your portfolio is diverse — the weighting of each investment matters too. For example, holding ten different stocks might look diverse, but if they’re all in the same industry, you’re still exposed to the same risks.
One way to assess diversification is by looking at how much of your portfolio is concentrated in one asset class, sector, or company. Tools and portfolio trackers can help you see where your money is spread and identify any gaps or imbalances.
See our full guide on portfolio management.
Diversification summary
Diversification is one of the simplest yet most effective ways to manage risk in investing. By spreading your money across different asset types, industries, and markets, you can give yourself a smoother journey towards your long-term goals.
Next in this series: How to rebalance your portfolio — why it matters and how to adjust your investments to stay on track.
When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than your original investment. Chip does not offer financial advice and this should not be considered as a personal recommendation.
