Suppose you have 20,000 euros to invest and invests all this amount in shares of a company. If the company's price drops or if it goes bankrupt, the entire investment will be at a loss. However, if you divide these 20,000 euros between various financial instruments, the gains of some can offset the losses of other instruments.
Each market behaves differently at each moment, so the most efficient way to obtain consistent returns over time is allocate your capital between different types of assets and markets.
Diversification provides higher growth potential, since the portfolio does not depend on a single company, fund or sector having a good performance. Therefore, if one of your investments does not perform well, others may perform better and compensate. In this way, you reduce your potential risk.
Diversification can be achieved in different ways:
• By asset classes: the simplest form of diversification is to distribute the capital between equities, fixed income or money markets. The proportions of the types of assets will vary in relation to the profile of the investor.
• By geographical areas: If you invest not only in Spain, but internationally, you avoid linking your investment to the evolution of a single market.
• By economic sectors: Invest in a variety of sectors including energy, financial services, industry, healthcare, etc. If you are betting on an equity portfolio, it is important that you consider investing in both cyclical and defensive sectors.
• By investment styles: This form creates a balance between funds that focus on growth-style stocks – offered by expanding companies – and those that invest in value-style stocks – those whose potential has not yet been recognized by the market. and therefore they are at a lower price than they should.
• By destination of the money: the evolution of investment strategies leads us to a new model known as ISR (Socially Responsible Investment), added to other categories such as ESG (Environmental, Social and Corporate Governance). According to the great experts in the field, we no longer have to talk about either of these two, since now the protagonist is the Sustainability (If you are not sustainable you are nobody) and it is mandatory in any portfolio to have such a diversification.
The important thing in a year like this, in which the world has rethought, is to have as an investment objective something as simple as the consistency, not changing criteria and seeking the long-term profitability. In short, common sense.