In this post, we\u2019ll explain what diversification is and why it matters, as well as how to diversify your portfolio. <\/p>\n\n\n\n
What makes a portfolio diversified?<\/h2>\n\n\n\n
Many investors think they have a well-diversified portfolio when, in reality, they don\u2019t. In The Elements of Investing<\/em>, Burton Malkiel (Wealthfront\u2019s Chief Investment Officer) and Charley Ellis (noted investor, author, and member of our Investment Advisory Board) outline the three dimensions of diversification you need to improve your chances of long-term investing success. <\/p>\n\n\n\n The three ways you can (and should) diversify your portfolio are: <\/p>\n\n\n\n Let\u2019s take a closer look at how to apply this to your portfolio. <\/p>\n\n\n\n Diversifying across assets means investing in the stocks or bonds of many companies and issuers, not just a few. This is valuable because, as a rule of thumb, holding a large group of stocks is a well established way to reduce your exposure to potentially volatile price fluctuations of an individual stock, or even a handful of stocks. <\/p>\n\n\n\n Doubling down on your company stock is a glaring example of not<\/em> diversifying across assets. Even if you work for Apple, Google, or Meta, owning too much of your own company stock has the potential to create serious financial problems if you lose your job and your company\u2019s stock loses value. In their book, Burton and Charley describe an Enron employee who invested her entire retirement savings in Enron stock through the company\u2019s 401(k) plan, only to lose her job and see her savings decimated when Enron unraveled.<\/p>\n\n\n\n This is an extreme example, but the general point is that individual stock ownership represents diversifiable risk<\/a> (in contrast to market or systemic risk<\/a>). Diversifiable risk, by definition, is risk specific to an individual company or industry that can be reduced by spreading your portfolio across a broad set of investments. To be diversified across assets, don\u2019t invest your entire portfolio in a single stock, and don\u2019t allow your company stock to dominate your portfolio after it has become vested and liquid.<\/p>\n\n\n\n Instead of investing a large amount of money in a single stock, consider investing your money in a group of stocks or broadly diversified index funds. For example, if you wanted to get exposure to US equities, you could consider a low-cost ETF like the Vanguard Total Stock Market ETF (VTI<\/a>), which gives you exposure to about 3,500 US stocks (including Apple, Google, and Meta) for a low 0.03% annual expense ratio (which means you pay $3 annually for every $10,000 you invest). <\/p>\n\n\n\n Another important way to diversify is across asset classes. Asset classes are groups of similar investments with shared characteristics. Because of these shared characteristics, their prices tend to move together in response to various events. You can improve your risk-adjusted returns by investing in multiple asset classes, because it is virtually impossible to predict which asset class is going to outperform the others in any given year. That\u2019s why Wealthfront\u2019s expert-built Classic portfolios<\/a> contain at least five asset classes, and sometimes more depending on your individual risk tolerance. <\/p>\n\n\n\n Anyone who tells you they can predict the performance of different asset classes with any reasonable consistency is either fooling themselves or trying to fool you. This is market timing, and you shouldn\u2019t bother with it. Jack Bogle, the founder of the Vanguard Group, had a great saying about trying to time the market: \u201cAfter nearly 50 years in this business, I do not know of anyone who has done it successfully and consistently. I don\u2019t even know anybody who knows anybody who has done it successfully and consistently.\u201d <\/p>\n\n\n\n To illustrate this point, we put together the table below. It displays the ranking of asset class returns (represented by ETFs) by year for the past 10 years. We included all of the asset classes we consider in constructing Wealthfront\u2019s Classic portfolios<\/a>. The key takeaway is that no asset class consistently wins or loses. <\/p>\n\n\n\n Source: Wealthfront<\/p>\n\n\n\n You might be surprised to learn that US stocks have only been the top-performing asset class for 4 out of the last 10 years. This is one reason we don\u2019t generally recommend investing your entire portfolio in US stocks. <\/strong>When US stocks have an especially good year (as they did in the most recent full year for which we have data, 2024), people wonder why their diversified portfolio \u201cunderperformed\u201d the US stock market. But there was no way to know ahead of time that US stocks would \u201cwin\u201d relative to other asset classes. Even if you take the view that US stocks have had several good years lately (in our analysis, they were the top performing asset class for 3 out of the last 5 years) there\u2019s no guarantee that that will continue to be the case. Consider, for example, the \u201clost decade\u201d for US stocks in the 2000s, when the S&P 500\u00ae finished the decade with negative returns. As the chart above shows, even in recent memory, US stocks haven\u2019t consistently outperformed other asset classes. Hence, it\u2019s wise to have other asset classes in your portfolio.<\/p>\n\n\n\n From year to year, a given asset class can have very different performance. Look at natural resources, for example. It was the worst-performing asset class in 2015, 2017, 2018, 2020, and 2023. But it was the best-performing asset class in 2016, 2021, and 2022. This kind of variation (volatility) is exactly why it\u2019s beneficial to own investments from a broad range of asset classes\u2013\u2013when you hold a diverse set of asset classes that fit your investment goals and risk tolerance, you\u2019re more likely to have high performers in your portfolio and<\/em> less likely to be exposed to sharp losses when a given asset class has a bad year.<\/p>\n\n\n\n The final dimension of diversification is time. It\u2019s better to invest as early in your career as you can to give your returns more time to compound<\/a>. There is nothing as magical in investing as generating returns on top of prior returns and repeating this over and over again. Albert Einstein reportedly said: \u201cCompound interest is the eighth wonder of the world.\u201d Of course, to take full advantage of compounding, you also need to stay invested through market ups and downs. <\/p>\n\n\n\n In an ideal world, you would invest a large amount of money as early as possible and leave it in the market for a very long time. Unfortunately, this isn\u2019t consistent with how most people earn (i.e. most people tend to earn a salary over time instead of having a lot of investable assets when they get started) and it might be necessary to work through some decisions (like buying a home or paying off student loans) before investing a large sum anyway. Plus, investing all at once can make you sensitive to the timing of your investments\u2014you might worry about picking the \u201cwrong day.\u201d <\/p>\n\n\n\n Because of this, too many investors suffer from decision paralysis: They are so afraid of picking the \u201cwrong day\u201d to invest, they end up not investing their savings at all. As a result, they miss out on valuable time in the market when their savings could have been growing and compounding. <\/p>\n\n\n\n Dollar-cost averaging<\/a> is a popular way to diversify across time and avoid this issue. Rather than picking the \u201cright day\u201d to invest, dollar-cost averaging is a process where investors break up a lump sum into several smaller amounts, and then invest a portion consistently on a set schedule. For example, an investor with a $20,000 bonus might invest $4,000 per month for five months instead of putting it all in the market on the same day. <\/p>\n\n\n\n Wealthfront\u2019s automation features make it easy to diversify across time: You can set up recurring deposits and our software will automatically handle the trades for you. You can invest a specific amount every pay cycle, for example, or use recurring deposits to dollar-cost average a large sum of money into the market. We\u2019ll also rebalance your investments automatically so your portfolio stays well diversified for your risk tolerance and goals over time.<\/p>\n\n\n\n If you diversify across all three dimensions recommended in this post, you\u2019re in a better position to increase your risk-adjusted returns over the long run\u2014and investing in a properly diversified portfolio doesn\u2019t have to be a lot of work. You can invest in Wealthfront\u2019s expert-built Classic<\/a>, Socially Responsible<\/a>, and Direct Indexing<\/a> portfolios with just a few clicks. Having a well-diversified portfolio also lets you benefit from rebalancing and tax-loss harvesting<\/a>. Wealthfront offers both of these services to clients at no additional cost. <\/p>\n\n\n\n <\/p>\n","protected":false},"excerpt":{"rendered":" Diversification is the practice of buying a variety of different investments with the goal of balancing risk and reward in your portfolio. A well-diversified portfolio can help you maximize your expected returns without taking on unnecessary or unwanted risk. This is known as improving your \u201crisk-adjusted returns.\u201d You can think of diversification as a way […]<\/p>\n","protected":false},"author":129,"featured_media":13595,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"inline_featured_image":false,"footnotes":""},"categories":[1282],"tags":[1302,1629,1281,1994],"coauthors":[2433,1270],"class_list":["post-13542","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-investing","tag-diversification","tag-dollar-cost-averaging","tag-investing","tag-three-dimensions-of-diversification"],"acf":[],"yoast_head":"\n\n
How to diversify your portfolio<\/h2>\n\n\n\n
1. Diversify across assets<\/h3>\n\n\n\n
2. Diversify across asset classes<\/h3>\n\n\n\n
![\"\"](\"https:\/\/canary.kcprod.info/blog\/wp-content\/uploads\/2025\/11\/Diversification-Chart-2.jpg\")
<\/figure>\n\n\n\n3. Diversify across time<\/h3>\n\n\n\n
Diversify your investments to build long-term wealth<\/h2>\n\n\n\n