7 diversification strategies for your investment portfolio

Investors assessing their investment options often focus on an asset’s return potential, but an equally important consideration is how portfolio risk is managed. Market ups and downs are a normal part of investing, and your portfolio mix can affect how much risk you take.

While you can’t avoid risk altogether, a diversification strategy can help you manage how different risks affect your overall portfolio performance over time.

What is an investment diversification strategy?

A diversification strategy is the process of distributing your investments across different asset types, industries and regions. By not relying too heavily on any single investment or market segment, your portfolio may be better positioned to manage periods of market volatility.

No matter how strongly you feel about a specific investment, many factors can affect its performance. These can include economic changes such as inflation or recession, shifts in competition, or company‑specific challenges that affect business performance.

Owning investments that respond differently in changing market conditions may help reduce sharp swings and provide a degree of stability to your portfolio. 

How to diversify your portfolio: Seven strategies investors often consider

Building a well-diversified portfolio involves more than simply holding different investments. A thoughtful approach explores how various assets interact across different market environments.

1. Determine investment correlation

Goal: Avoid owning a large percentage of investments that tend to move together.

Investment correlation describes how different investments tend to move compared to one another. Even if you own many different investments, your portfolio may not be well diversified if those investments tend to rise and fall together.

For example, high-yield bonds often have a positive correlation with stocks, particularly during certain market environments. As a result, a portfolio made up only of high‑yield bonds and stocks is not effectively diversified. 

2. Diversify across asset classes

Goal: Don’t rely too heavily on any single type of investment.

Diversifying across asset classes means spreading your money among stocks, bonds, cash and real assets. This approach helps ensure your portfolio doesn’t rely too heavily on any single market or investment type.

There are several asset classes to choose from, including:

• Equities (stocks)
• Fixed income investments (bonds)
• Cash and cash equivalents
• Real assets including property and commodities

These asset classes tend to generate different returns and carry different risk characteristics. Including investments across asset classes is often a first step toward building a diversified portfolio. A solid diversification strategy typically includes exposure to multiple asset classes. Many investors use mutual funds or exchange‑traded funds (ETFs) to gain exposure to multiple asset classes, industries or regions through a single investment.

3. Diversify within asset classes

Goal: Limit the effect any one company, sector or issuer can have on your overall portfolio performance.

Diversifying within asset classes means owning a range of investments within the same category, such as stocks from different industries or bonds that mature at different times. This can help reduce the impact of risks tied to a single company or sector.

Methods of diversifying within an asset class include:

• Industry: If you invest in energy stocks, consider adding tech, biotech, utility or retail sectors to your portfolio. Even within an industry, it can pay to be diversified. Company‑specific issues can cause two companies in the same industry to perform very differently.
• Fixed income investments (bonds): Look for bonds with different maturities and from different issuers, including the U.S. government and corporate entities.
• Funds: While index funds track the overall stock market, other funds focus on specific segments. Check the types of securities in which your funds invest to make sure you’re not overly exposed to a specific category.

4. Diversify by geographic location

Goal: Reduce exposure to economic or policy risks tied to any one country.

Geographic diversification means investing in both U.S. and international markets to help reduce country‑specific risks. Adding foreign stocks and bonds can help balance your portfolio when domestic markets face economic headwinds.

For example, if you only own U.S. securities, your portfolio is primarily exposed to U.S.-specific economic and policy risk. However, while foreign stocks and bonds can add diversification, they also come with country-specific risks. These include foreign taxes, currency movements and political or economic risks.

5. Explore alternative investments

Goal: Add assets that may behave differently than stocks and bonds.

Alternative investments are assets outside of traditional stocks and bonds, such as real estate, commodities or reinsurance. Including these options may provide added diversification since they may exhibit lower or different correlation to traditional markets.

• Real estate investment trusts (REITs) own and operate properties such as office buildings, shopping centers or apartment complexes. REITs may provide diversification benefits over time, although their correlation with stocks can increase in certain market conditions.
• Commodity investments involve physical goods ranging from gold to natural gas to wheat and even cattle. You can buy commodities directly or through a commodity fund.
• Reinsurance helps insurance companies manage large risks. Investors can access it through pooled funds and earn returns from premiums paid by the insured companies. Performance is often influenced by weather-related rather than the traditional business cycle.

6. Rebalance your portfolio regularly

Goal: Maintain your intended risk level over time.

Rebalancing means adjusting your investments to maintain your original target mix. Even a diversified portfolio requires periodic rebalancing. Over time, certain investments will gain value while others decline. Rebalancing is a way to balance risk and potential return, helping your portfolio stay on track during market highs and lows.

There are certain situations that might trigger rebalancing, including market volatility and major life events. Tax considerations may also play a role in how and when rebalancing occurs, particularly when investments are held across different types of accounts. Read more about when to rebalance your portfolio.

7. Align investments with your risk tolerance

Goal: Match your portfolio mix to your time horizon, financial goals and risk comfort level.

Risk tolerance is the degree of market volatility you’re willing to take on to pursue your financial goals. Your views about investment risk can impact your diversification strategy. Generally, the longer your investment timeframe, the more you can weather short-term losses and capitalize on the potential of long-term gains.

• Aggressive investors generally have a longer time horizon or more appetite for risk. They may accept more market volatility and invest more heavily in growth assets.
• Moderate investors generally have a medium-term time frame or some comfort with risk. They often consider a balanced mix of stocks and bonds.
• Conservative investors generally have little risk tolerance or need their money in a shorter time frame. Their portfolio may be comprised mainly of low-risk assets, such as bonds and cash equivalents.

These examples are illustrative only and may differ based on individual financial circumstances. Evaluate your personal risk profile and invest appropriately based on that.

Frequently asked questions about investment diversification

Can a portfolio be over-diversified?

Yes, over-diversification occurs when adding new investments no longer meaningfully reduces risk and may dilute your potential returns. Having too many overlapping funds or assets can also make your portfolio overly complex and difficult to rebalance.

Is cash considered part of a diversified portfolio?

Yes, cash and cash equivalents are an important part of a diversified investment portfolio. Holding cash can help provide stability during market downturns and give you the liquidity needed to cover short-term goals or emergencies.

How does age affect how to diversify your portfolio?

As retirement nears, many investors shift their portfolio diversification toward more conservative assets like bonds and cash. This strategy may help protect funds from sudden market downturns.

Do target-date funds provide a diversified investment portfolio?

Target-date funds offer a built-in diversification strategy by automatically adjusting your asset allocation over time. They hold a mix of stocks, bonds and cash that gradually becomes more conservative as you near your target retirement year.

Build a diversification strategy that’s right for you

A diversification strategy is designed to help manage how market risks affect your portfolio over time. Review whether your portfolio diversification aligns with your goals, risk tolerance and time horizon, and revisit it periodically as circumstances change.

Whether you want to invest on your own or receive personalized financial guidance, we have investing options to meet your needs.