Reducing risk is one of the main objectives of diversification. For this strategy to be effective, your investments must not all fluctuate in the same direction at the same time.
There are several ways to diversify your investments. Know that you don’t have to use all of these types of diversification.
The table below shows different ways you can do so.
Have guaranteed investments that mature in 1 year, 5 years and 10 years. Therefore, if interest rates drop, you don’t have to reinvest all of your investments at lower rates.
Have investments in Canadian and U.S. dollars, as well as other currencies.
Financial institutions, fund managers
Allocate assets between two financial institutions; buy funds managed by different firms.
Not all markets move in the same direction. The Canadian market may be on a downswing, while global markets are performing strongly, or vice versa. Diversification can be achieved through Canadian and foreign investments, for example.
Own stocks of natural resources companies, financial institutions, consumer goods, etc.
Hold shares of different companies.
Types of products
Hold shares, bonds, guaranteed investment certificates (GICs), etc.
Two hypothetical examples of diversification
Here are two hypothetical examples to help you understand how you can diversify through stocks.
Hypothetical example 1 – An investment with and without diversification
Two pharmaceutical companies (A and B) are conducting extensive drug discovery research. The company that develops the drug first will generate a 20% return for investors, while the company that doesn't succeed will incur losses of 10%.
Let's assume that the two companies have an equal chance of developing the drug.
Peter and John each have $10,000 to invest.
Hypothetical example without diversification
Hypothetical example with diversification
Peter invests the entire $10,000 in Company A.
John prefers to invest $5,000 in Company A and $5,000 in Company B.
This hypothetical example shows how diversification can help you reduce the overall risk of your investments.
Hypothetical example 2 – Diversify for a higher return
Sam likes John’s proposed diversification, but feels that a 5% return won’t allow him to reach his objectives.
He thinks that Company A will discover the drug first. However, he’s willing to risk a drop in his investments on the chance that they’ll bounce back even higher. On the other hand, he’s not ready to risk all of his capital.
So, he splits up his $10,000 investment as follows:
He invests $6,667 in Company A and $3,333 in Company B.
- If Company A markets the drug first:
Sam makes 20% ($1,333) on his $6,667 investment but loses 10% on Company B ($333). That leaves him with a total profit of $1,000, or a 10% return.
- If Company B wins the race:
Sam loses 10% ($667) with Company A but makes 20% ($667) with Company B. So he doesn’t gain or lose.
With this hypothetical example, there's a 50% chance that Sam will make 10% on his investment, and a 50% chance that he’ll come out even.
Documentation and tools
- Reviewing Your Personal Finances (pdf - 5 MB)This link will open in a new windowUpdated on 14 June 2016
- Choosing an Investment Dealer or Representative (pdf - 4 MB)This link will open in a new windowUpdated on 22 August 2016
- Red-flagging financial fraud (pdf - 7 MB)This link will open in a new windowUpdated on 23 October 2015