Building a diversified share portfolio for beginners

Human hand stacking generic coins over a black background with hexagonal golden shapes. Concept of investment management and portfolio diversification.

Portfolio diversification is one of the central tenets of the share trading world. It’s a time-tested strategy that serves to mitigate risk by balancing a portfolio of investments, ultimately generating stable returns.

It’s often talked about in relation to a proverb: ‘Don’t put all your eggs in one basket.’ The eggs refer to your hard-earned cash and the basket is a single share or investment. 

While it’s a cliche, it presents a very possible predicament. If that basket of eggs falls, you could be left scrambling to sell your shares at a price far below what you paid for them.  

Whether you’re a beginner share trader, or you’re looking for a way to shuffle your existing shares around, consider diversification as a means of creating a solid foundation for your portfolio. 

Here’s how it’s done.

What does it mean to diversify your share portfolio?

Diversification, in terms of share trading, refers to the practice of buying shares across various companies, industries, and markets, in order to reduce the risk of all your shares performing poorly at once. 

Essentially, diversification is a defence against unfavourable market movements.

Why diversify your share portfolio?

The reason many investors suggest having a diverse portfolio is to spread around the inherent risk that comes with stock trading – losing all or part of the money you’ve invested, due to circumstances outside your control. 

Let’s look at an example of a portfolio that hasn’t been diversified to demonstrate the vulnerability of narrow investing.  

Imagine you’re only invested in a couple of mining stocks. Suddenly, a new law or regulation comes into play that restricts the mining industry’s activities in some way. This would likely cause your fellow investors to sell off their mining stocks, resulting in the value of your shares plummeting.  

In that example, your whole portfolio relies on the stability of only one sector – mining. So, if share prices in that sector fall considerably, then it’s likely your whole portfolio will follow suit. 

If your portfolio was diversified, however, you might not lose as much – you’d have other investments in other industries, or, other eggs in other baskets. 

But diversification can also mean investing across several different asset classes – groups of financial instruments that hold common characteristics, such as shares, bonds, cash, real estate, commodities, and currencies. 

If one of your asset classes falls in value, the other asset classes you’re invested in might balance out your losses by remaining stable, or in the best scenarios, rising. 

Let’s have a look at how diverse portfolios reduce this risk.

How share portfolio diversification reduces risk

Diversification spreads the risk around several different investments and can help to balance out losses and stabilise returns. 

If you have a diverse share portfolio, when some of your investments lose value, others may rise. 

For example, while your shares in mining might be falling in value, your shares in another sector, like renewable energy, might help to offset your losses by rising.

How to diversify a share portfolio

To diversify your portfolio, you can invest in a range of market sectors (e.g. energy, utilities, and industrials) and invest in exchange-traded funds (ETFs)

Invest in different market sectors 

When creating a diversified share portfolio, focus on investing in a variety of shares. 

This means investing in a mixture of industries (or market sectors), not just a mixture of companies in the same sector – although, owning shares across multiple companies in a sector is also a viable way to add diversification to your share portfolio. 

Some of the main market sectors you can invest in include:

  • Energy (oil, natural gas, and coal) 
  • Materials (manufacturing goods) 
  • Industrials (construction and engineering)
  • Utilities (electricity, water, and renewable energy)
  • Healthcare (pharmaceuticals, biotech, and healthcare services)
  • Financials (banks, insurance companies, trusts)
  • Consumer discretionary (retail, automotive, luxury goods, hotels)
  • Consumer staples (groceries, household products)
  • Information technology (software and hardware) 
  • Communication services (telecommunications, media, and internet companies)
  • Real estate (developers and project managers). 

How to diversify your portfolio with ETFs

Investing in ETFs is another way to diversify your share portfolio. 

ETFs are bundles of investments that usually have some degree of diversification built in. They can help you to diversify your portfolio through asset class diversification, market diversification, and sector diversification.

If you’re looking to diversify your share portfolio, make sure you compare share trading platforms to find one that gives you access to the companies, sectors, markets, and products (like ETFs) that you want to invest in. If you want to check out some award-winning platforms, a great place to start is with the best share trading platforms in 2023

If you prefer to trade on the go, then make sure you research share trading platforms for mobile to compare the features of some great mobile trading apps.

Share account comparisons on Mozo - rates updated daily

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Do diversified portfolios have the highest returns?

While diversified portfolios can provide more stable returns over the long term, they might not provide as high a return as concentrated portfolios – share portfolios that invest in only a few companies or sectors.  

Of course, there are factors that contribute to your own portfolio’s returns, like overall market and individual company performance. So, there’s never going to be one right answer when it comes to the performance of your share portfolio.

Can you over-diversify a portfolio?

Diversification, while recommended, can be a double-edged sword if you over-diversify your shares. 

The problem with over-diversification stems from the idea that adding new investments to your portfolio lowers your risk by stabilising your returns. This happens because investments that perform poorly might be balanced out by those that do well. 

So, if you have too many diverse investments, this could result in the stagnation of your portfolio’s returns. 

For example, if your portfolio is over-diversified, then any large gains you might make from owning stocks could be countered by a series of smaller losses from other investments.