This article covers:

• Diversification Across the ASX

• Diversification Across Regions and Markets

• Diversification by Industry

• Diversification by Investment Theme or Goal

• Diversification Over Time

• Why Diversification Remains so Important

Ask many successful fund managers and investors how they managed to build their wealth, and they'll likely tell you that portfolio diversification played a big part. Put simply, diversification involves spreading your money across multiple investments. Basically, not putting all your eggs in one basket.

Diversification is used to manage risk, reduce volatility, and smooth out portfolio returns. Too much diversification can also be a bad thing. The more investments in your trading account, the less influence each investment has. This can make it harder for your portfolio to outperform the market. Nonetheless, diversification is a key strategy to build long-term sustainable wealth. Not just across shares, but also assets like property and cash.

When investing in the stock market, there are multiple ways to diversify your portfolio. Here we discuss five strategies to diversify your share portfolio, and why it is so important.

Diversification Across the ASX

Most investors would have some understanding on how to build a diverse portfolio of ASX shares. This means holding a 'basket' of ASX shares within your Selfwealth online trading account. While putting all your capital into one stock might seem appealing, it is a high-risk scenario.

By mitigating your exposure to any single stock, you decrease the risk of significant portfolio losses that might accompany any negative news tied to that stock. As unlikely as it might seem, all shares have the potential to go to zero. There are plenty of well-known case studies from years gone past, including Ten and Virgin Australia.

There is no 'magic' number of stocks you should hold to diversify your portfolio. This will vary from one investor to the next. It will also depend on the type of stocks you choose, and the size of your portfolio. The average Selfwealth member owns less than 10 different holdings, however, many investment professionals suggest around 15-20 different stocks can help you diversify your portfolio.

Diversification Across Regions and Markets

There are three options to diversify your portfolio by geography.

Thanks to our US share trading and Hong Kong share trading, you can invest directly in thousands of stocks from across the globe.

Australian investors often focus on ASX stocks because of their familiarity and ease of access, among other factors. However, Australia represents just 2% of all global market opportunities.

This means there is a wealth of opportunity accessing international shares. The US stock market is the largest in the world and there are a number of benefits of investing in US shares. Meanwhile, the Hong Kong Stock Exchange is the sixth-largest stock market in the world. It also offers several advantages to Australian investors.

If investing directly in US or Hong Kong stocks seems daunting, many ASX-listed ETFs provide exposure to international shares. ETFs are a simple, cost-effective option to instantly diversify your portfolio. You gain exposure to a 'basket' of stocks through one investment. Some ETFs even protect against foreign exchange movements.

Lastly, keep in mind that Australia is home to numerous large companies with global operations. These companies typically operate in markets where economic conditions differ from those in Australia. They may even have exposure to the US dollar. These stocks provide a third option to diversify your portfolio by region.

Diversification by Industry

Diversification by industry tackles one of the common gripes regarding the highly-concentrated ASX.

At first glance, with over 2,000 stocks available to invest in, the ASX appears to offer a diverse range of shares.

But look a little closer and you will see approximately 60% of the ASX 200 is weighted towards companies in the materials, financials, and real estate sectors. The local tech sector accounts for less than 4% of the weight of the ASX 200.

If you want to diversify your portfolio, look at the industry exposure across the stocks you own. Many investment professionals invest in stocks from a wide number of sectors or industries.

Some of these industries go through cycles. This includes cyclical stocks across commodities, like iron ore and oil. Some segments also take off at certain times, driven by external factors or emerging trends. For example, consider the rise of battery metals stocks in response to growing uptake of electric vehicles.

Diversification by Investment Theme or Goal

Many investors like to focus on a particular investment goal, be it capital growth or income.

Each has its own merit, and targeting both can also help you diversify your portfolio. Investing in growth stocks can yield long-term capital appreciation. On the other hand, stable blue-chip dividend stocks can provide ongoing income, provided you identify shares paying sustainable dividends.

When markets turn volatile, it is often high-growth stocks that are hit hardest. When the market rallies, these stocks tend to outperform. Some stocks offer exposure to both themes, but it isn't easy to find these companies.

Another emerging theme that has grown in popularity is Environmental, Social and Governance (ESG) investing. There is an extensive list of ETFs targeting this investment theme, offering exposure to a basket of 'ethical' and 'responsible' stocks. Selfwealth features an ESG rating tool to help you review stocks against an expansive framework of ESG criteria.

Diversification Over Time

Last but not least, many investors diversify their portfolio without even realising it. How, you might ask? By diversifying over time.

This is due to dollar cost averaging (DCA), which is a strategy where you buy shares in a certain stock at set intervals, and for the same dollar amount each time.

When you make one large purchase of a particular stock, also called lump sum investing, you are placing more weight on the share price of that trade. If you stagger your buying activity via dollar cost averaging, you are spreading your exposure across time.

If the stock trades below your original purchase price, dollar cost averaging means you would end up buying a higher volume of shares in that stock at the next interval. If the share price is higher, you would end up buying fewer shares at the next interval. By taking advantage of natural fluctuations in the share market, DCA can help you reduce risk and diversify your portfolio.

Why Diversification Remains so Important

Although diversification can potentially cap your returns, it is important to manage risk and aim for consistent returns. A portfolio with low diversification can expose you to unnecessary risk and potentially magnify your losses.

Each of the strategies discussed in this guide will help you diversify your portfolio in different ways. No single approach is necessarily better than another. You should base your decision on your investment goals and risk appetite. However, using several diversification strategies in unison offers sound protection against portfolio volatility, which is helpful to achieve sustainable long-term returns.