Diversification

A portfolio that is not diversified is disproportionately exposed to specific risk, even if it theoretically has a high expected return. This means that a single event, such as an unexpected profit warning from one holding, can lead to catastrophic losses that cannot be offset by the other holdings.

The goal of diversification is to build a portfolio where negative surprises from some of the holdings are neutralized by positive or neutral developments in other parts, creating a more stable and predictable return profile.

Effective diversification goes beyond simply owning many stocks. It requires a deliberately strategic placement of assets that are not perfectly correlated with each other. This means actively seeking investments that react differently to the same macroeconomic events, such as changes in interest rates, inflation or growth.

A well diversified portfolio acts as a buffer system, where the volatility of individual stocks is dampened, providing a calmer investment journey and reducing the risk of having to sell at a low point.

A practical starting point is to build a portfolio with a base of assets that have low correlation with each other. This means combining stocks, which have historically delivered higher returns but also higher volatility, with assets such as bonds and government bonds that tend to be more stable and often react positively when the stock market falls.

For the more advanced investor, the inclusion of alternative assets such as infrastructure funds, REITs or even a small allocation to gold can further strengthen diversification and reduce the overall portfolio volatility.

Diversification is then applied within each asset class. For the equity portion, this means spreading investments across different sectors (e.g. technology, healthcare, finance) and geographical regions (Sweden, Europe, North America, Asia). This protects against sector-specific shocks and regional economic downturns. It is also important to think about size classes, where a mix of large established companies and smaller growth companies can provide balanced exposure.

The portfolio should then be reviewed regularly, since correlations between assets change over time and individual holdings can become too large or too small relative to the original strategy.