Investment Portfolio – Diversifying Equity
If you want to create passive earnings in your asset portfolio, the best way to do this is through investing. One of the most critical aspects of investing is capital allocation – which is how you’ll invest your money across industries, company sizes, and geography of your portfolio. Since 2020, a number of people have grown more interested in investing. The rise of Robinhood, Instagram stock gurus, online education and robo investing has raised awareness around the stock markets as high as ever. Does that mean that everyone should invest in the S&P 500 ETF (SPY) and call it a day? Of course not. Investing in equity is always a good idea, but diversifying the type of equities you invest in can help lower your risk in your portfolio.
How To Diversify Your Equity
To begin, the S&P 500 is made up of some of the largest, most capitalized companies in the world. They are often multi-billion dollar global enterprises that have mastered their craft and have become one of the best performing businesses in their industry. So, it makes sense to add these companies to your portfolio. However, some of the weaknesses of investing in the S&P 500 for long term growth is that it excludes many non-US businesses, smaller companies and private investment opportunities.
Although the S&P 500 is well diversified across US-based large scale businesses, the number of investment opportunities in other geographies may very well be the balance that your portfolio is looking for in terms of short term diversification and long term returns. The US has historically been one of the most efficient places to do business via stock exchanges. As the digital revolution continues, countries everywhere are creating more efficient capital markets to provide capital to their most successful companies. This creates investment opportunities as companies now have a sustainable pathway to financing. Lastly, in a growing globally connected economy, finding opportunities in international based businesses is a great way to continue to further diversification. Markets across Europe, South America, and Asia are filled with sophisticated investors, quality companies, with strong management teams. The U.S. is far from being the only market in town.
Second, small cap stocks often perform better in the long run vs their large cap peers. The small capitalization companies are often where some of the most innovative ideas are still being fleshed out. Whether in technology, healthcare, or renewable energy, there are a number of businesses that can grow tremendously without ever reaching the Trillion Dollar club that Apple, Microsoft, and Amazon find themselves in. Below is a 20 year chart showing the Russell 2000 (small caps) vs S&P 500 (large caps).
Source: SeekingAlpha
Other Types of Asset Diversification
The same theory can be applied to private businesses. With the growth of crowdfunding, and increased access to early stage or more mature private companies, accredited investors and non-accredited investors can start to take risks with their portfolio that can pay off huge. By putting 5-10% allocation to alternatives like venture capital and private equity, you can earn two benefits. The first being long term capital appreciation as businesses continue to grow in value and benefit investors. The second is diversification across markets, as liquidity in private investments is far more difficult to sell out of based on a knee jerk reaction, meaning its investor base will be in it for the long run. That obviously can be both good and bad but can help keep the management team of such investments focused on what matters rather than dealing with a volatile stock.
Source: AngelList
So as you consider your equity investments, think about how you can not only get into the market, but also how you can increase equity exposure across sectors, geographies, and market caps to participate in long term gains.
