Diversification is one of the most effective techniques to ensure a smooth investment experience. As an investor, this involves distributing your funds over a variety of investments. Why? Different sorts of investments perform differently over time. While some increase in value, others may decrease or maintain their value. So variety helps to even out your returns. Read the blog to learn about diversification of the stock portfolio for Canadian investors:
What Is Diversification in Investing?
Diversification is the process of distributing investments across asset classes, industries, and geographies in order to minimize an investment portfolio’s total risk. The theory is that by diversifying your investments, the poor performance of one can be offset by the higher performance of another, resulting in a more consistent overall return.
How to Diversify Your Investments
If you want to build your stock portfolio, you need to learn what is diversification and how to diversify your investment first. Diversification begins by spreading your investments across the three main asset classes: cash, fixed income, and equities. But how much of your portfolio should go into each? The answer depends on your unique circumstances and preferences as an investor.
Here are some key considerations:
- What are your goals? Understand why you’re investing and what you aim to achieve.
- What’s your timeline? Consider how much time you have to reach your goals.
- How much risk can you handle? Assess both your emotional comfort with risk and your financial capacity to absorb losses. Market fluctuations are inevitable—will a dip in value keep you up at night?
By addressing these questions, you can make informed decisions about where to allocate your investments. Explore the interactive chart below to see how a well-diversified portfolio can help you achieve growth while minimizing the impact of market volatility.
Why Diversify Stock Portfolio is Important for Canadian Investors
Many Canadian investors feel that buying an index mutual fund or index exchange-traded fund (ETF) will provide appropriate stock diversity. These are essentially baskets of shares from several firms that comprise an index, such as the S&P/TSX Index (which includes approximately 250 of the 1,500+ companies listed on the Toronto Stock Exchange).
Relying on an S&P/TSX Index fund is risky, however, because two-thirds of the index is concentrated in just three sectors: financial services, energy, and materials. When global economic activity slows, energy and commodity prices suffer. This, in turn, affects financial organizations, which rely on faltering resource industries for a big portion of their revenue.
The S&P/TSX Index is heavily influenced by a few highly correlated sectors, making it challenging for Canadian investors to mitigate losses by diversifying within smaller sectors like health care. These sectors are relatively underrepresented, offering limited options for effective diversification. To achieve true portfolio diversification, Canadian investors must look beyond domestic borders, expand into global markets, and explore opportunities outside of traditional equities.
Given the complexity of navigating international markets and alternative investment options, seeking guidance from a financial consultant can be invaluable. A professional can help identify less-correlated investments, tailor strategies to your financial goals, and ensure your portfolio remains balanced and resilient against market volatility.
Diversifying Across Sectors and Industries
Diversifying within a sector or industry, as seen above by purchasing railroad equities to protect against negative changes in the airline industry. In this scenario, an investor is looking to invest in the transportation sector and has numerous stakes in the industry.
You may want to diversify even further because of the risks connected with these companies. That’s because anything affecting tourism in general will harm both industries. This suggests you should consider diversifying outside of the industry.
Diversifying Across Companies
Diversification across companies involves spreading your investments among multiple businesses to reduce the risk associated with any single company’s performance. Instead of investing heavily in one company, allocate your funds across different industries and sectors. For example, if you invest in a technology company like Shopify, consider balancing it with shares in a utility company like Fortis or a consumer goods company like Loblaws.
This way, if the technology sector faces a downturn, your portfolio is cushioned by the stability of other sectors. Diversifying across companies ensures that your investments are not overly dependent on the success of one business or industry, improving your portfolio’s resilience.
Diversifying Across Asset Classes
Different asset types respond differently to broad macroeconomic conditions and help you to create your diversify stock portfolio. For example, even if the Federal Reserve boosts interest rates, equity markets may outperform due to the economy’s relative strength. However, higher interest rates hurt bond prices.
More current portfolio theory advocates diversifying into alternative assets, a developing asset class that goes beyond equities and bonds. With the advancement of digital technology and accessibility, investors can now readily invest in real estate, cryptocurrency, commodities, precious metals, and other assets. Again, each of these classes has unique levers that determine what makes them effective.
Understanding the Different Types of Risk
Investors face two primary types of risk. The first is systematic risk, which impacts all companies and industries and cannot be reduced through diversification. It stems from factors like inflation, interest rates, political instability, or global events. The second is unsystematic risk, which is specific to a company, industry, or market. Common sources include business and financial risks. Unlike systematic risk, unsystematic risk can be minimized through diversification by spreading investments across various assets, reducing the impact of market-specific events on a portfolio.
Pros and Cons of Diversification
| Pros | Cons |
| Reduces risk by spreading investments | May dilute potential high returns |
| Protects against market volatility | It can be challenging to manage a diverse portfolio |
| Provides exposure to various sectors | Requires time and research to diversify effectively |
| Improves long-term portfolio stability | Transaction costs may increase |
| Mitigates impact of poor-performing assets | Over-diversification can limit portfolio growth |
FAQs
How to get a 10% return on investment in Canada?
Investing isn’t one-size-fits-all; strategies like debt repayment, short-term stock trading, art and collectibles, junk bonds, MLPs, real estate, long-term stocks, and starting a business offer diverse opportunities. Each has unique risks and rewards, allowing you to balance growth and stability while building a strong financial foundation.
How to diversify your stock portfolio in Canada?
You may be able to reduce the risk of suffering significant losses by diversifying into uncorrelated assets like cash instruments (Guaranteed Investment Certificates (GICs), high-interest savings accounts), or negatively correlated assets (bonds).
What is the best investment to make in Canada?
The best investment in Canada depends on your goals and risk tolerance. Popular options include stocks and ETFs for growth, real estate for rental income and appreciation, and registered accounts like RRSPs and TFSAs for tax advantages. Mutual funds and GICs are safer options for conservative investors while starting a business or investing in alternative assets like REITs or commodities can offer higher potential returns. Always assess your financial situation before deciding.
Wrapping Up
Diversification can assist an individual investor in managing risk and reducing the volatility of an asset’s price changes. Remember, however, that no matter how well-diversified your portfolio is, risk will never be eliminated. Furthermore, diversity may result in missing out on above-average returns related to a firm or industry, which could be captured by a more active but less diverse approach.
However, suppose you are not a professional investor. In that case, you should aim to reduce the risk associated with holding specific stocks, considering that general market hazards affect practically every stock.