What is asset diversification?

Asset diversification is an investment strategy that involves allocating capital among different assets to reduce risk. The basic idea is that assets react differently to market changes. Therefore, with proper diversification, losses in some assets are offset by gains in others. There are several types of diversification.

• Sectoral — investing in companies from different sectors of the economy (for example, technology, medicine, and real estate).
• Geographic — spreading assets across different countries and regions. For example, investing in the US and Asia.
• By asset class — using different types of assets (stocks, bonds, real estate, precious metals, cryptocurrencies).
• Currency — investing in assets denominated in different currencies to reduce currency risk.

Diversification helps reduce risk, but it does not guarantee returns. It is important to choose the right investments and balance your portfolio according to your financial goals and risk tolerance.

What exactly does diversification offer, and against which risks does it provide protection?

Diversification is a strategic principle that forms the basis of effective portfolio management. It involves the conscious allocation of capital between assets that react differently to market changes. The objective is straightforward: to minimise risk without significantly compromising potential returns. But which risks does it help to reduce, and how does it work?

First, the risks associated with any investment can be divided into two broad groups: systematic and unsystematic. This distinction helps us to understand the true value of diversification.

Non-systematic vs. systematic risk

Systematic risk is impossible to avoid, but possible to mitigate

It affects the entire market or most assets simultaneously. It cannot be avoided because it is an integral part of the economic cycle. Systematic risks include:

• Changes in central bank interest rates.
• Inflation and currency devaluation.
• Economic downturns or recessions.
• mGeopolitical instability.
• Global energy or financial crises.

When global financial turbulence strikes, almost all markets react in the same way — prices fall. For instance, declines were observed in virtually all asset classes, including equities, real estate and even bonds, during the 2008 crisis and the 2020 pandemic.

Non-systematic risk is the kind that can be eliminated

Unlike systematic risk, non-systematic risk is local or specific. Rather than being related to the market as a whole, it is tied to individual companies, sectors, or countries. Such risks can be controlled or even eliminated through proper diversification.

Typical examples include:

• A company releases an unsuccessful product and its shares fall.
• A bank faces a liquidity problem.
• Or a regulator may change the rules for a specific sector, such as crypto exchanges or agricultural companies.

If an investor only owns shares in one company, internal difficulties can be catastrophic. However, if the portfolio contains 15–20 different companies from various industries, even the collapse of one of them will only affect a small portion of the total capital.

How do these factors interact?

Each asset in the portfolio carries a share of two types of risk: systematic risk, which relates to the state of the wider economy, and unsystematic risk, which depends on the circumstances of the issuer. When a portfolio contains numerous assets, the unsystematic risks offset each other, and the overall risk of the portfolio approaches the level of systematic risk.

Consequently, if an investor has only one asset, the risk is high. With each new asset, the risk decreases, but after a certain number — approximately 20–25 independent positions — the effect flattens out. Further diversification no longer significantly reduces risk because the systematic component becomes residual.

The effect of 'smoothing' returns

Investors are accustomed to thinking in terms of profit, asking questions such as, 'How much will I earn in a year?' However, it is equally important to consider how this profit is generated. One portfolio may yield a +15% return over the course of a year, but experience several sharp peaks and troughs. Another may yield only +10%, but this will be achieved consistently and without emotional swings.

The second scenario is the result of yield smoothing. This enables you to predict capital dynamics, make informed decisions and avoid panicking when individual markets fall. For professional investors, such stability is often more valuable than achieving the maximum return.

How does it work?

The basic idea is that different assets behave differently in different economic conditions.

• For example, when inflation rises, commodities and real estate benefit.
• When interest rates fall, however, bonds and large-cap stocks rise.
• When the economy slows down, pay attention to gold and infrastructure funds.

Combining these assets in a single portfolio means that some of them will always perform well. This reduces the amplitude of fluctuations and makes the yield curve smoother. Let's imagine a hypothetical portfolio in which:

• 40% is invested in developed market equities.
• 25% is invested in government bonds.
• 20% is invested in real estate or REITs.
• 10% is invested in commodity assets.
• 5% is invested in gold.

According to historical models such as MSCI and Bloomberg Indices, such combinations have shown lower volatility than a single portfolio over the past 15 years. At the same time, the average return has remained similar.

Let's say an investor had two portfolios in 2020.

• Portfolio A contained only shares in US technology companies.
• Portfolio B comprised a mix of 50% US and European shares, 30% bonds, 10% gold, and 10% real estate.

When tech giants such as Meta, Amazon and Tesla fell by 30–50% between 2021 and 2022, Portfolio A declined significantly. Portfolio B, thanks to its diversification, fell by only 10–12% on average.

In other words, while the difference in returns over five years may be insignificant, the emotional burden and risk of capital loss are much lower. This is known as the smoothing effect.

Smoothing works not only between asset classes, but also between geographical markets. Different economies move according to their own cycles:

• For example, the US may grow when Europe slows down.
• Southeast Asian countries boom when Latin America is in decline.

Therefore, a portfolio that includes shares from different regions experiences fewer drawdowns and recovers more quickly from local crises. For instance, during the EU's energy crisis, investors with exposure to Asian or American assets experienced smaller losses.

A brief guide to asset classes with examples

Currency as protection against devaluation

One of the basic strategies for preserving the value of money in countries with high currency risks, such as Ukraine, is to hold part of your capital in USD/EUR. Devaluation of the hryvnia, caused by factors such as war, inflation or financial instability, can quickly reduce the purchasing power of savings. Experienced investors, therefore, advise having a currency safety cushion — a portion of your savings in US dollars or euros — to stabilise your portfolio and provide liquidity in times of crisis.

Devaluation of the hryvnia directly affects all domestic assets, including deposits, real estate, stocks and everyday goods. Meanwhile, foreign currency assets not only retain their nominal value, but often grow in hryvnia terms too.

Foreign currency deposits

The easiest way to obtain a foreign currency safety cushion is to open a bank deposit in dollars or euros. This option is ideal for conservative investors looking to preserve their funds and earn a modest passive income (approximately 0.5–3% per annum in foreign currency). The main advantages are simplicity, clarity, and state guarantees. However, there are also disadvantages, such as low returns and a limited choice of foreign currency deposits in banks during wartime. There is also the risk that interest rates will not compensate for inflation in dollars or euros.

Currency bonds

A more advanced instrument is domestic government bonds, which are denominated in foreign currency. These are available to large investors and individuals through banks or brokers. The yield on such securities is typically 3–5% in US dollars or 2–4% in euros, depending on the maturity date. The main advantages are the reliability of the issuer (the state) and the ability to plan income in a foreign currency. However, they are less liquid than deposits: bonds cannot always be sold instantly, especially in times of crisis.

Another option is corporate currency bonds or Eurobonds issued by large Ukrainian and international companies. These offer higher yields (5–8% in currency), but also entail increased credit risk. This option is only viable for a private investor if they understand the issuer, the debt structure, and the possibility of diversification.

Currency funds (ETFs and mutual funds)

ETFs allow you to invest directly in currency assets through an international broker. For instance, you could purchase a fund comprising US government dollar bonds or European corporate bonds. The return depends on market rates and currency dynamics. These funds offer a convenient way to earn passive income in a foreign currency without having to purchase individual securities.

Some Ukrainian brokers offer currency investment funds (CIFs) for investors who do not have access to international exchanges, forming a portfolio of currency assets. While this is convenient, you need to carefully check the commissions and management transparency.

Digital and alternative assets represent a new wave of investment in an era of change

Digital assets are all investment instruments that exist in digital form and are stored on the blockchain, such as cryptocurrencies (e.g. Bitcoin and Ethereum), stablecoins (e.g. USDT), project tokens and tokenised assets (e.g. real estate or stock tokens). The main advantages are accessibility and decentralisation: you can invest from anywhere in the world without the need for banks or intermediaries.

Digital assets allow you to:

• Quickly transfer funds between countries.
• Invest in international projects without bureaucracy.
• Participate in new forms of the economy, such as DeFi, GameFi and the metaverse.

However, volatility and risk remain, as cryptocurrency rates can fluctuate by tens of per cent in a matter of days, and the market is not fully regulated.

Alternative assets are a broader category that encompasses everything beyond traditional financial instruments, including venture capital, private equity, hedge funds, art, collectable wines and even shares in football clubs. These assets usually have low liquidity and a higher entry threshold, but also offer the potential for significantly higher returns.

Alternative investments are attractive because they enable you to diversify beyond a conventional portfolio. For example:

• Venture capital investments involve investing in early-stage startups and can yield a return of 10–50 times the initial investment if successful.

• Private equity involves investing in private companies. This typically requires substantial sums (from £50,000), but enables you to become a co-owner of the business.

• Crowd investing is a modern, democratised form of investment where even a few hundred pounds can buy a stake in a project.

• Collectables, such as art, NFTs, vintage cars and wine, are emotional investments that combine financial gain with an element of prestige.

Both digital and alternative assets carry several risks:

• High volatility: cryptocurrency prices can fall by 50–70% for no objective reason, and up to 90% of startups fail.

• There is also legal uncertainty; for example, not all tokens have a clear legal status.

• Technical risks include losses due to hacker attacks, phishing and improper storage of private keys.

• Venture or asset investments may have low liquidity.

Diversification, caution, and counterparty verification are therefore essential. It is not advisable to invest all your funds in cryptocurrency or a single startup. It is better to distribute funds across several areas: up to 10% in digital assets, 20–30% in traditional assets and the remainder in liquid instruments.

Stocks

Investing in company stocks offers the opportunity to earn a return through capital appreciation and dividends. However, stocks can be more volatile and risky for several reasons.

1. Price movements are driven by supply and demand. When investors buy or sell stocks en masse, their prices can change rapidly.
2. Influence of news and events. Corporate earnings reports, macroeconomic data, geopolitical events, or even social media postings can have a significant impact on a stock's price.
3. Dependence on the state of the economy. During economic crises, companies' financial performance declines, which lowers their share price.
4. Speculative interest. Some stocks may be subject to speculation, which increases their volatility, i.e. sharp fluctuations in price.
5. The company's financial performance. If a company has high levels of debt or unstable earnings, its shares will be riskier.
6. Liquidity. Less popular stocks may have lower trading volumes, so even small purchases or sales can have a large impact on the price.

Because of these factors, stocks are riskier than bonds or deposits, but they also offer potentially higher returns over the long term.

Bonds

These are debt instruments that provide fixed income and are less susceptible to market fluctuations. Bonds are an important part of stabilising an investment portfolio for various reasons.

1. Low volatility. Bonds, especially government and investment-grade bonds, are less prone to sudden changes in value. This helps to smooth out fluctuations in the overall portfolio.
2. Protection in times of crisis. During economic downturns or stock market crises, investors often move into safe investments such as government bonds. These can hold their value when stocks fall.
3. Fixed income. Unlike stocks, which may not pay dividends, bonds offer predictable interest payments, providing a steady stream of income.
4. Capital preservation. Government bonds and high-quality corporate bonds have a lower risk of default, making them a good option for capital preservation.

Bonds with a Ukrainian context

Ukrainian government bonds are the most popular choice for investors seeking stability. The main advantage of these bonds is that they are guaranteed by the state. Despite military risks, Ukraine has never defaulted on its domestic debt, even during the most challenging of times.

They are available to retail investors through banks or brokers. The minimum investment amount is typically several thousand hryvnia, with rates exceeding 17–19% per annum in hryvnia as of 2025. Importantly, these securities are exempt from personal income tax, which increases their real yield.

For investors seeking to reduce currency risk, dollar- or euro-denominated bonds are available. These offer lower returns (approximately 3–5% in currency terms), but this is offset by asset stability. This makes them a good option for those looking to maintain the purchasing power of their capital.

The corporate bond market in Ukraine is still developing, but there are already examples of successful placements, such as UkrEnergo, Kernel and Nova Poshta. Such securities attract investors with higher yields (up to 20–25% in hryvnia), but require more in-depth analysis of the issuer. The risk of default is significantly higher than for government debt instruments.

The main advantage of corporate bonds is the opportunity they provide to support Ukrainian businesses by investing in debt securities with clear payment terms rather than speculative stocks. For experienced investors, this forms part of a diversification strategy.

Military bonds are issued by the state and have been since 2022. The purpose of these bonds is to raise funds for defence and reconstruction. For investors, they have financial value as well as patriotic value. Their yield is comparable to that of ordinary government bonds, and they are considered even safer due to special state support.

These securities are ideal for conservative investment strategies where investors seek a stable income and minimal risk of loss.

The main risks are related to the macroeconomic situation, such as inflation, exchange rate fluctuations, military spending and restrictions on foreign exchange transactions. When assessing these securities, it is important to consider not only the nominal rate but also the real yield after taking devaluation into account. For instance, an 18% return in hryvnia may appear appealing, but if the hryvnia depreciates by 15% over the year, the actual yield in dollar terms is negligible.

The key is balance: some capital should be invested in hryvnia securities for high returns and some in foreign currency securities for stability.

When comparing Ukrainian bonds with bank deposits, the former often offer better value for money: they are tax-free and provide higher returns. In addition, bonds can be sold on the secondary market, adding liquidity. However, for beginners, a deposit may be a simpler option due to the lower entry threshold and absence of brokerage infrastructure.

Real Estate

Real estate investments can provide regular income through rental income. This asset class is generally less volatile but requires a significant investment. Flats, land, houses or commercial premises are expensive and tenants are not always easy to find. In addition, external factors such as economic problems, natural disasters or wars can affect the value and condition of assets.

Commodities

Commodities such as gold, silver, or oil can act as “safe-haven” assets in times of economic instability. They typically have a low correlation to traditional financial assets.

The principles of building a diversified portfolio: a practical framework

Defining goals and risk profile

Your risk profile shows how much market fluctuation you are willing to tolerate, how you react to temporary losses, and how long you are willing to wait for results. One investor may calmly watch their portfolio fall by 20%, understanding that this is part of the cycle, while another will sell everything at the first sign of danger. Another investor, however, may sell everything at the first sign of danger. Knowing your profile helps you to avoid making emotional decisions and to choose a strategy that suits your risk tolerance, goals, and investment timeframe.

Typical investor profiles

Conservative investor: The main goal is to preserve capital. Such investors do not chase high returns and prefer stability. Their portfolio usually consists of 60–80% bonds (government or corporate), 10–20% deposits and defensive assets such as gold or currency funds. For a conservative investor, reliability is key.

Moderate investor: This is the most common type of investor among private investors. They are willing to take a certain amount of risk to achieve moderate but stable growth. A typical portfolio includes 40–50% stocks, 30–40% bonds, 10% alternative assets (such as gold, real estate investment trusts (REITs) and currency instruments), and a small portion of cash. This balance allows for higher returns than those of a conservative investor, but without taking on excessive risk.

Aggressive investor: Their goal is to maximise profits, even if it means significant fluctuations in the portfolio's value. A high proportion of equities (up to 80%), including international ETFs, venture capital funds, and crypto assets, enables long-term capital growth. The remaining 20% is usually distributed between bonds and liquid instruments to maintain a balance. Aggressive investors think in terms of five to ten years and accept temporary losses as part of the process.

Examples of basic proportions

Once you have determined your risk profile, the next step is to create a portfolio that aligns with your objectives, risk tolerance and timeframe. Below are three classic approaches: conservative, balanced, and growth. These are not investment advice, but merely illustrate the basic logic of portfolio construction.

A conservative portfolio offers stability and predictability

The main goals of this type of portfolio are capital preservation and predictable cash flow. The investor is not seeking maximum returns, but wants to avoid sharp fluctuations in value. Typical structure:

• 60–70% government or reliable corporate bonds.
• 20–30% in deposits, including foreign currency deposits.
• 5–10% in gold or other defensive assets.
• Up to 5% is invested in blue-chip stocks (large, stable companies).

The yield is 8-12% per annum in hryvnia or 3-5% in foreign currency. Although risks are minimal, the portfolio will hardly grow in real terms amid high inflation.

A balanced portfolio strikes a balance between risk and return

This is the golden mean of investing. The goal is to achieve higher returns than a conservative portfolio while maintaining relative stability. Typical structure:

• 40–50% equities (ETFs, large companies and selected promising industries).
• 30–40% bonds (government, municipal and reliable corporate).
• 10% — alternative assets (gold, REITs, commodity ETFs and crypto funds).
• 5–10% in currency instruments (USD/EUR deposits and funds).

The average return is 12-18% in hryvnia or 5-8% in currency. The risks are moderate — declines of 10-15% are possible during periods of crisis, but the portfolio has the potential to recover.

Growth portfolio: maximum profit potential

The main goal is capitalisation, i.e. long-term growth in asset value. This type of portfolio is aimed at investors with a time horizon of 5–10 years who are prepared to withstand significant fluctuations. Typical structure:

• 70–80% equities (including international ETFs, technology companies and emerging markets).
• 10–20% bonds or fixed-income funds to reduce volatility.
• 10% — alternative instruments, such as venture funds, crypto assets and real estate.

The potential return is 20%+ per annum in hryvnia terms, or 10–15% in currency terms. The risks are high, especially in the short term, but the potential long-term returns are also high.

Geographical and sector diversification

Geographical logic: USA, Europe, Asia/EM

The key idea behind geographical diversification is that economic cycles and growth drivers behave differently in different regions of the world. The USA remains a leader in innovation and technology, with a high proportion of companies in the IT, consumer services, and finance sectors. Europe is known for its stable businesses that pay dividends, particularly in manufacturing, pharmaceuticals and energy. Meanwhile, Asia and emerging markets offer the potential for rapid economic growth, albeit with a greater risk of political instability or regulatory changes.

Combining these three regions allows for synergy between different phases of the cycle. For example, when the American market slows down, the European or Asian markets may be experiencing an upturn. For instance, weak dynamics in the S&P 500 index may be due to the Fed's tight monetary policy, while growth in the MSCI Asia index may be thanks to the recovery of consumer demand in China or India.

Consequently, investors are not dependent on the success of a single country or continent. The following structure is often recommended for a modern portfolio: US: 50–60%; Europe: 20–30%; Asia and EM: 10–20%.

Sectoral logic: combining defensive and cyclical industries

As well as considering geography, it is important to diversify across economic sectors.

• Defensive sectors are those for which demand remains stable at all stages of the economic cycle, such as healthcare, utilities, and consumer staples. While they do not show explosive growth, they also rarely fall into crisis.

• Cyclical sectors include technology, automotive, finance and manufacturing. Their revenues grow during economic upturns, but may decline during recessions.

The ideal portfolio strikes a balance between the two types of sectors. For instance, an investor could allocate 50% to cyclical sectors such as technology and manufacturing, and 50% to defensive sectors such as pharmaceuticals and consumer goods. This reduces portfolio volatility during market downturns.

ETFs are a quick way to diversify

An ETF combines the simplicity of a share with the advantages of an investment fund. By purchasing a single ETF, an investor effectively owns a share in a portfolio consisting of dozens, or even hundreds, of assets. Rather than buying each company in the S&P 500 index individually, for example, it is sufficient to purchase one ETF that mirrors the structure of this index. This provides instant access to a broad market, reduces risk, and saves time.

One of the main advantages of ETFs is their low fees. Traditional, actively managed funds often charge 1–2% per annum for management services. Passive ETFs, on the other hand, cost an average of just 0.05–0.3% per annum. While this difference may seem insignificant, over the long term it can save investors tens of thousands of pounds. For investors with a 10–15-year time horizon, this is one of the key factors in increasing returns.

Another reason why ETFs have become a popular tool among both retail and professional investors is their accessibility and liquidity. They are traded on the stock exchange like shares, so they can be bought or sold at any time during the trading day. This creates flexibility when it comes to responding quickly to market events, rebalancing or forming short- and long-term strategies.

Diversification through ETFs is not only about geography, but also about asset classes. Some funds track:

• Stock indices (e.g. S&P 500, Nasdaq, MSCI World).
• The bond market (government or corporate).
• Commodity markets, particularly gold, oil and raw materials.
• Industrial ETFs: Cover specific sectors such as technology, energy, or biotechnology.
• There are also thematic ETFs related to trends such as artificial intelligence, green technology, or cybersecurity.

Regular portfolio rebalancing

When one asset class grows faster than the others, its proportion of the total portfolio increases. The investor then partially sells this asset (locking in profits) and uses the proceeds to buy more of the cheaper assets. This restores the portfolio to a balanced structure, making the risk controllable again.

There are two main approaches:

• The time-based method involves rebalancing according to a calendar, for example, once a year or every six months. This is the simplest option and suits most investors. At regular intervals, the portfolio is reviewed and brought into line with the planned weights.
• The threshold method involves rebalancing when the weight of a particular asset deviates by a certain percentage (e.g. ±5%) from the target value. This approach is more flexible as it only takes action when the market has actually changed.

Some investors combine both methods, reviewing their portfolio quarterly but only taking action in the event of significant deviations.

Imagine an investor with a portfolio consisting of 60% stocks and 40% bonds. Over the course of a year, the stock market grew, and the share of stocks in the portfolio increased to 70%. This would seem great — the shares have made a profit. However, the portfolio has now become riskier than planned. Therefore, the investor sells some shares and buys bonds, returning the balance to 60/40. This locks in profits and reduces potential losses if the stock market falls.

Conversely, when stocks fall, rebalancing involves buying more assets at a lower price — precisely when most people are panicking. In this way, the investor acts against market emotions, following logic and strategy instead.

Incidental expenses and taxes

When building a portfolio, investors often focus on potential returns, market dynamics and the right choice of assets. However, incidental expenses and taxes can quietly erode profits. While this may seem insignificant in the short term, over a period of 10 years, for example, even small percentages of expenses can significantly reduce the final capital.

The Total Expense Ratio (TER) is an indicator of the costs involved in managing a fund (whether an ETF or a mutual fund). It includes fees for the management company, custodian, auditor, administrative fees, and so on. TERs are automatically deducted from a fund's assets, so investors do not see these costs directly, but they do affect returns.

For example, if two ETFs track the same index, but one has a TER of 0.10% and the other has a TER of 1.0%, the long-term difference in results will be significant. Investing £100,000 for 20 years at an annual rate of 8%, an additional commission of 0.9% would reduce the final amount by over 20%. Therefore, a low TER is not just a bonus, but a critical selection criterion.

The second type of expense is brokerage commissions. These are fees charged for buying and selling securities, as well as for account maintenance. For an active trader, such expenses can be significant, as each transaction incurs a cost. For a passive investor holding ETFs or shares for years, commissions are minimal, but should still be considered when calculating the expected return.

In addition, it is worth checking custody fees, as some brokers charge small monthly or annual fees for portfolio maintenance. While these fees may seem insignificant at first, with a small capital, they can eat up a significant portion of your income.

In Ukraine, investors pay income tax on investments: an 18% personal income tax plus a 1.5% military tax. This applies to profits from the sale of assets, as well as to dividends or coupon income. If investments are made through a Ukrainian broker, the broker usually acts as a tax agent. If investments are made through a foreign broker, the investor must declare their income themselves.

It is also worth considering double taxation of dividends. For example, American companies withhold 15% tax on dividend payments at source. Thus, investors actually receive less than stated in reports.

Many investors underestimate the impact of commissions and taxes on compound interest. If the annual return on a portfolio is 8%, but total expenses (TER, broker fees and taxes) amount to 2%, the net return is only 6%. In the long term, this makes a significant difference. For instance, £100,000 invested for 25 years at an annual return of 8% will grow to approximately £684,000. However, if the net return is only 6%, the result will be ~£430,000. This loss of more than £250,000 is entirely due to expenses.

How can true diversification be measured?

Correlation, and why having many positions does not equate to real diversification

Correlation is an indicator of how two assets move relative to each other. If they rise and fall simultaneously, there is a high positive correlation between them. If one asset rises while the other falls, there is a negative correlation. It is this difference that creates real portfolio protection.

For example, an investor might own shares in large technology companies such as Apple, Microsoft and Nvidia. From the outside, this looks like diversification — three different companies in different sectors. However, if the technology market falls due to changes in interest rates or sentiment, all three stocks will fall at the same time. Consequently, the portfolio behaves as if it were a single asset.

Therefore, it is important to track not just the number of positions, but also how they are interdependent. Experienced investors check the correlation between asset classes, such as stocks, bonds, gold, real estate and venture capital. The idea is simple: find a combination where some assets behave differently from others. When the stock market slumps, gold or government bonds may retain their value. Venture investments, although less liquid, often follow their own logic, independent of daily stock market fluctuations.

True diversification means building a portfolio in which risks are not concentrated in a single sector or type of behaviour. It is an ecosystem in which the decline of some elements is offset by the stability of others.

Volatility, drawdown, and investment horizon

The second dimension of diversification is the ability to withstand fluctuations. Volatility refers to the change in the value of an asset over time. High volatility is not necessarily undesirable. It is acceptable if the investment horizon is long. For instance, a venture capitalist investing in startups over 7–10 years is not concerned about short-term drawdowns — what matters is that the potential return compensates for the risks.

Conversely, short-term investors should avoid assets with excessive volatility. If funds are needed within a year or two, significant price fluctuations could wipe out profits or force you to sell at an unfavourable time. Therefore, when diversifying, you should consider not only the type of assets but also your time horizon.

Another important aspect is the maximum drawdown of the portfolio. This shows how much the portfolio can fall from its peak value to its minimum. A well-diversified portfolio experiences lower drawdowns because its components react differently to stress.

Ultimately, diversification is a process of balancing risk, time and asset behaviour, not a magic formula. Investors who measure the degree of correlation between positions rather than the number of positions achieve greater protection and more stable returns in the long term.

Common mistakes in diversification and how to avoid them

Over-diversification

Paradoxically, investors can sometimes be so eager to reduce risk that they actually increase it. This occurs when an investor adds too many assets to their portfolio without properly analysing or understanding their role.

Adding numerous assets, especially inefficient or highly correlated ones, can reduce the potential for high returns from the best assets. This results in average market performance without any significant advantage from diversification.

The more assets you have, the more difficult it is to manage your portfolio, track the performance of each component, rebalance and analyse risks. It can also lead to higher fees and tax expenses.

An investor may believe that they are fully protected by having dozens of different investments, but if these investments are closely correlated or involve similar risks (for example, stocks from only one region or sector), there is no real diversification.

Insufficient diversification

Insufficient diversification can appear to be overconfidence in one's own knowledge. In venture capital, this occurs when an investor puts all their eggs in one basket, region, or even one startup.

Insufficient diversification does not always mean a lack of assets — sometimes it is a lack of ideas. For example, a portfolio consisting of five startups that all depend on one trend — such as the consumer subscription market or API solutions — is insufficiently diversified. Even if each company is successful, if the global trend changes, the portfolio becomes vulnerable.

Insufficient diversification can also be an emotional mistake. Investors often become emotionally attached to their own ideas or a charismatic founder.

Ignoring analysis and liquidity

Put simply, liquidity is how quickly an asset can be converted into cash without losing significant value.

Imagine you have created a portfolio of ten projects, some of which are early-stage startups and some of which are private companies without a stock market listing. On paper, the portfolio looks brilliant, but when market conditions change or new opportunities arise, it becomes impossible to sell the stake. Such situations are common in venture capital: deals are finalised, investors are bound by shareholder agreements, and liquidity may only become available years later during an IPO or M&A.

This is why it is important to always check the liquidity of assets. This does not mean that long-term investments should be avoided, but rather that every portfolio should have an appropriate level of liquidity. Some funds should be invested in less liquid assets, such as venture capital, private equity and real estate, while the rest should be invested in highly liquid instruments, such as exchange-traded funds, bonds, and money markets. This balance enables you to manoeuvre without selling strategic positions in times of crisis.

Ignoring fundamental analysis is equally critical, as well as ignoring liquidity. Investors often invest based on emotions or trends rather than assessing actual financial performance. Even in venture capital, where many decisions are based on potential rather than reports, there are still basic metrics such as user growth rates, burn rate (cash expenditure), unit economics, LTV/CAC and market share. Without these indicators, it is difficult to determine whether a company will survive until the next round of financing.

Ignoring liquidity analysis can create an illusion of control. While it may seem that the portfolio is growing, its real value may only exist on paper. During periods of crisis, investors are unable to exit or reallocate funds. This is precisely what happened to many funds in 2022-2023, when the market halted IPOs, and it became impossible to sell startup shares on the secondary market.

Ignoring risk and correlation

Risk is not the enemy of the investor, but their natural environment. However, a lack of understanding of risk can cause losses, even in well-diversified portfolios. While everyone talks about the need for a diverse portfolio, few pay attention to the correlation between assets — that is, how one asset behaves in relation to another.

Imagine a portfolio consisting of shares in five large American technology companies. On the face of it, it is diversified: different brands and products. In practice, however, all these companies depend on one factor: the US technology market. If this sector falls, they all fall at the same time. Therefore, although there are many positions, there is effectively only one risk.

Ignoring risk also manifests itself in the absence of a quantitative assessment. While many investors rely on intuition, a professional approach requires clear metrics such as volatility, VaR (value at risk) and the Sharpe ratio. Similar logic can even be applied to a venture portfolio: assess how many companies are at high risk of defaulting, which ones have positive cash flow and which ones depend on further rounds of funding.

The key principle is that risks do not disappear just because they are not discussed. If all assets behave similarly, even ideal diversification in terms of quantity will not help. Correlation makes a portfolio vulnerable because, in a crisis, all positions can move in the same direction.

Quick investor checklist

Below are ten key points to consider before making any investment, whether in the traditional stock market or an early-stage venture deal:

• Define your goals. Investing without a goal is like sailing without a course. Knowing why you are investing is important: are you looking to build capital, generate passive income, or achieve long-term growth? Your goal determines your time horizon — whether it's three years or ten — and influences your choice of instruments.

• Define your risk profile. Everyone has their own tolerance for loss. This depends on factors such as age, income, experience, and financial cushion. For a beginner, it would be normal to have a large share of stable assets, while an experienced investor may consciously take on the risks of high volatility.

• Consider your asset proportions. The balance between risk and stability is achieved through asset allocation. One example would be 60% in public instruments (such as stocks and bonds), 30% in alternatives (such as venture capital and real estate), and 10% in cash or liquid reserves. The same principle applies to a venture capital portfolio, comprising several high-risk startups and several with stable metrics.

• Geographical diversification: Markets in different regions react differently to events. Even a small proportion of international assets can mitigate the effects of local crises. In venture capital, this means investing not only in the domestic market but also in startups in the US, Europe, and Asia, to reduce the impact of regional risks.

• Sector diversification is also important. If your entire portfolio consists of fintech or AI startups, that's not diversification; it's concentrated risk. Diversifying across sectors — such as technology, healthcare, education, and ecology — ensures stability.

• Currency exposure: Just as market fluctuations can affect returns, so too can exchange rates. This is why it is significant to hold assets in different currencies or use hedging strategies. This is particularly relevant for venture capital funds, where profits are often tied to the US dollar, while expenses are tied to the local currency.

• Regular rebalancing is also essential. No portfolio remains balanced forever. An annual review enables you to restore proportions, secure profits, and adjust risk levels.

• Control your expenses and taxes. Excess profits can disappear due to commissions or suboptimal taxation. Transaction costs, fees, and taxes on profits all need to be considered from the outset. In venture capital, this means understanding the structure of special purpose vehicles (SPVs), the taxation of exit transactions and options.

• Update your plan. The world is changing, and your strategy must change with it. New technologies, markets, and tools are constantly emerging. It is worth reviewing once a year whether your portfolio still matches your goals, risk tolerance, and market trends.

• Discipline. The most important thing is to act consistently. An investment strategy only works when it is adhered to. Psychological pressure from the market, hype, and the fear of loss can often be the biggest enemies.