Diversification strategy, what is it?

We'll tell you how to apply this strategy and lower the risk of your investments.
Investment products have become the go-to instrument for small savers who want a return on their disposable capital. When preparing an investment portfolio, both individuals and professionals in the sector tend to follow very different strategies depending on their profile and objectives. However, there is a basic principle for trading in financial markets that is usually common to all investment plans: diversification. In this article, we explain what a diversification strategy consists of and how to implement it in order to get the maximum returns on your capital.
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What is a diversification strategy?

Portfolio diversification consists of allocating the investment capital between assets of different characteristics in order to reduce the risk associated with these operations. In keeping with this approach, investing in assets that exhibit totally different behaviors entails an overall risk that is lower than the sum of the individual risks of each component in the portfolio. So if an asset has a downward trend in the market and generates losses, they can be offset by the profits yielded by the other assets. In fact, some diversification strategies involve assets that are inversely correlated. The inverse correlation between two assets occurs when the value of one increases while that of the other decreases.

As a result, a diversification strategy allows lowering the risk associated with an investment portfolio by reducing the impact of negative returns on the portfolio as a whole. Every investor, regardless of their risk profile, whether conservative or aggressive, should embrace diversification. An aggressive investor whose timeline allows them to invest in risky assets should develop a diverse portfolio of, for example, stocks. The portfolio will have an aggressive profile but without being subject to the performance of a single security, which is always undesirable.

Ways to diversify investments

When diversifying a portfolio, there are different methods that are classified based on the characteristics of the assets to be purchased: 
  • Numerical or company diversification: it consists of allocating the total capital you want to invest among different companies instead of putting it all into a single company. For example, instead of investing €20,000 in Inditex shares, it may be more advisable to invest €2,000 separately in 10 different IBEX-35 companies.
  • Time diversification: in other words, regular investments instead of one-time investments. For example, it is more convenient to pay into an investment fund monthly (12 times a year) than once a year on a given date, since monthly payments tend to give an average purchase price that evens out market swings and avoids buying at a market peak.
  • Diversification by sector: each of the sectors that makes up the current market exhibits its own specific characteristics and behavior during different economic cycles. This diversification criterion makes it possible to offset the negative impact that a certain sector can have on the investment as a whole. In fact, different variables influence each sector, such as the impact of the price of oil or seasonal concerns. Diversification by sectors also reduces risk.
  • Geographical diversification: although the economy is increasingly globalized and interconnected, each country still exhibits its own unique financial behavior and trends. Dividing the capital among different geographical regions dilutes the risk associated with a downturn in one of the regions. At the investment level, the world is divided into regions, including North America, Latin America, Europe, the Euro area, Africa, Asia Pacific and Japan.
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  • Diversification by currency: this method, which involves investing in the assets of international companies that use different currencies, is closely related to geographical diversification. Although allocating capital among different countries that share the same currency, such as the Eurozone territories, in itself reduces the potential risk of the investment, it also means that capital is exposed to fluctuations in that currency. Because of this, a geographical diversification strategy should be accompanied by currency diversification, for example, in euros and dollars. It is also possible to seek geographical diversification without incurring currency risks through strategies to hedge against these risks.
  • Diversification by type of asset: this is the most widely used strategy in the field of portfolio diversification. This method of diversification involves combining assets in different categories, such as fixed-income, equities or foreign exchange assets. A well-diversified portfolio should have a certain percentage of each asset type. It's important to keep in mind that every asset has various sub-assets. For example, there are equities from small, medium and large companies. Fixed-income securities also have several classifications, such as corporate or government securities.

At BBVA, we offer a wide range of investment products that are tailored to your profile and personal goals. Visit bbva.es and discover the diversification characteristics and strategies of our deposits, investment funds and pension plans. With BBVA, the investment is tailored to you.

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