What is diversification when investing?

Learn how to lower your investment risk.
Investing is not as risky as it seems, and is within everyone's reach, if it's done properly. Investment risk can be minimized easily by keeping certain guidelines in mind and adopting basic strategies, such as diversification. Next, we explain what the latter is and how it can help you invest more securely.
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What does diversification entail?

When a person has an important meeting or trip, they usually set alarms on different devices so as not to rely solely on their alarm clock and risk being late. In the financial sphere, it is also common for consumers to have several bank accounts, whether in one or more banks, so they can take advantage of the benefits they offer and reduce their risks. The concept of diversification when investing is based on this same principle: instead of concentrating all the investment in a single variable, it is divided among several to minimize risk and exploit a greater number of opportunities. As the saying goes, "Don't put all your eggs in one basket."

Since it's impossible to predict exactly how the various markets and companies will evolve, diversification is a safer option, as it strikes a balance between the yields of different assets. If you invest in a single company and its results are negative, you could incur significant losses. If, on the contrary, your investment portfolio includes other companies, this loss may be offset by the positive results of others. In short, it's a strategy that allows you to opt for greater returns while reducing the level of risk.

How to diversify an investment?

Diversification can take place on several levels: assets, currencies, geographical location, etc. Let's look at it in detail:

  • Time diversification: choosing the best time to invest is practically impossible. Although there are forecasts, it's hard to know with certainty if you're selling at the high or buying at the low. Time diversification consists of investing small amounts periodically rather than investing the total at once. The shares are thus bought at different prices, with the higher prices being offset by the lower ones. With any purchase, you run the risk of catching the price at its peak, which the ensuing drop in the price. Periodic investments should thus be a priority.
  • Diversification according to the type of asset: the different types of assets have different levels of return and risk. Fixed-income assets are generally more stable than equity assets, but they also have lower returns. Therefore, investing exclusively in equities can be excessively risky, especially for conservative investors. However, an investment that combines both can bring greater returns with a moderate level of risk. More diversified portfolios include assets such as currencies or real estate.
  • Diversification by type of company: There are different types of companies, depending on their capitalization and whether they are a value or growth company. A properly diversified portfolio relies on these different profiles.
  • Diversification by sector: allocating an investment among different companies must also include companies from different sectors. Companies in the same sector can exhibit similar trends and be affected by the same factors. For example, companies in the technology sector have high potential returns, but in times of crisis they can trend downward. In this case, having allocated part of the investment to companies that produce other types of goods can offset the results, since different sectors usually have different economic cycles.
  • Diversification by currency: changes in the prices of different currencies can also affect the return on investment. Therefore, investing in companies that use different currencies is another way to minimize the risk of losses due to the depreciation of a specific currency. If you prefer not to be exposed to currency risks, they can be offset with hedging strategies that rely on derivatives.
  • Geographical diversification: the economic, social and political situation in a country or region is an important factor in the share price of the companies in that area. So as not to rely exclusively on the circumstances of that market, investments should be diversified among companies in different parts of the world.
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Investment funds: diversification within reach

Although ideally an investor would diversify using all the methods discussed, many investors don't have sufficient resources to acquire a personal portfolio that is sufficiently diversified. Contributing to this are products such as investment funds, which, under the philosophy of collective investment, allow investors to diversify while investing less and paying lower fees. For example, someone who has 3,000 euros in an investment fund owns the proportional part of that amount, which will depend on the weight that managers assign to each security, invested in the 30 or 40 securities that comprise the fund portfolio. Replicating this strategy by buying shares directly isn't possible, since the brokerage costs would make it inefficient.

At BBVA, we offer a wide range of investment products that let you diversify and get the highest possible returns. See our section on savings and investing at bbva.es or visit any of our branches for more information.

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