Investment diversification

Whether you trade stocks, Forex, or options, an important part of reducing your risk is diversifying your investment. Putting all your money on a horse is high risk and is a sign of a player, not an investor. No technical analysis or momentum prediction is 100% foolproof and every investor should be aware of periodic drawdowns.

Diversification in investment: 3 factors to consider.

It is helpful to break the topic down into different questions that you consider separately before bringing them together for your final investment decision.

• Risk and reward

• Diversification of the exhibition

• Portfolio rebalancing

Risk and reward

Each investment vehicle or strategy has a different risk profile, and you should be aware of this. Similarly, each approach has a potential reward profile. In most circumstances, the reward is directly proportional to the risk. This means that the more profit you hope to make, the more risk you must be willing to handle. A good investor tries to balance this.

For example, trading ETFs is low risk, but the return on investment (ROI) is barely higher than the inflation rate. Trading DITM (Deep-in-the-Money) options can increase the reward without increasing the risk. Trading buy-and-hold stocks (for a stock with good fundamentals) can be profitable, especially if you reinvest dividends. Selling covered calls on your equity portfolio can increase your ROI without increasing risk. Buying call options is very risky unless you are an expert swing trader, but the rewards are staggering. Selling option spreads is slightly less profitable in the long run, but the risk profile is even lower than buy and hold strategies.

Diversification of the exhibition

The market has different sectors and each sector has different cyclical patterns of growth or decline. Your investment plan should include stocks or options from each sector. As money flows from one sector to another, you can keep track and plan your investments accordingly. You should never have more than 2-3% of your portfolio committed to a particular stock and never have more than 20% designated to a certain sector.

Portfolio balance

Every year or every quarter, you need to look at how well your portfolio is balanced. In a given period of time, some sectors will grow while others will remain static or contract. This can throw your portfolio out of balance. As a responsible investor, you need to rebalance your investment diversification. So maybe you’ve divided your portfolio evenly between Forex, ETFs, REITs, option sales, and favorite stocks to buy and hold. If you make bold profits selling options, you can take these profits and reinvest them in the other sectors so that the ratio remains the same.

The learning curve

It is easier, but more risky, to stick with an investment strategy. It is worth investing the educational effort in several strategies. This may be one of the most important factors in reducing your risk profile. Serious investors, who do not feel like gambling, will make this investment. Diversification in investing is one of the most powerful earnings factors, simply because it keeps you from losing money.