CFDs are complex financial instruments and come with a high risk of losing money rapidly due to leverage. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money. CFDs are complex financial instruments and come with a high risk of losing money rapidly due to leverage. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.

Finetuning your investment strategy

Lesson 4 of 6

The importance of diversifying your portfolio

Diversification is your first line of defence against risk in your portfolio. It’s the practice of allocating your funds across a range of investments to limit exposure to a single type of risk.

An undiversified portfolio is one that has holdings in assets that are too closely related, and this could result in higher losses during a downturn.

Example

Say you own shares in a local fuel producer and a local transport company. If your country experienced a long-running oil shortage, both your holdings would be impacted because the oil and transportation industries depend on each other.

The fuel producer would lose profits due to the limited oil supply, which could mean decreased sales. Subsequently, a fuel shortage would likely result in price hikes that could impact the transport company’s bottom line.

And depending on the severity of the shortage, the transporter could also face operational challenges if there’s no oil available to fuel its vehicles, or lose more money to importing its supply.

In the scenario above, you bought shares in two dependent sectors within the same geographic location and economic environment. So any dramatic changes to one could directly impact the other.

Think about what would’ve happened had you also bought shares in an oil company from another country – one that’s one of the biggest oil producers in the world, for instance.

Homework

Make a list of five assets you may want to invest in and put them in a table like the one below. Make sure you look up any information you’re unsure about so that all the details are as accurate as possible.

We’ve placed three examples below to help guide you. You’ll see from the examples that two of these assets are equities, but each of them is from a different country and is priced in a different currency.

Holding Market Currency Asset class Sector
Volkswagen Germany EUR Equities (shares) Motor
British Airways Great Britain GBP Equities (shares) Travel
Gold Bullion Securities Ltd USA USD Exchange-traded fund (ETF) Commodities

There are many ways you can diversify your portfolio. As you’ve seen above, you can vary your investments by the countries, sectors and asset classes you buy, and even the currencies you use to do so.

More advanced market participants can use different financial instruments, such as CFDs, to diversify their portfolios. We’ll take a deeper look into this in the next course.

Lesson summary

  • Diversification can help protect you against major losses
  • It involves buying a variety of assets in different regions, currencies and sectors
  • You can also diversify your portfolio by the financial instruments you choose to buy or sell
Lesson complete