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The importance of diversifying your ASX portfolio and how you can do it

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In order to maximise your potential returns and limit the damage of market shocks, I believe investors should ensure that their portfolio is diversified.

A good example of why this is important is the big four banks. The best performer in the group in 2020 has been the Commonwealth Bank of Australia (ASX: CBA) share price with a decline of 26% year to date. The other three big banks are each down approximately 38% since the start of the year.

While Commonwealth Bank’s decline may not look that terrible compared to the 18% decline by the benchmark S&P/ASX 200 Index (ASX: XJO), it is important to note that the big four banks are playing a major role in the ASX 200’s decline.

If you were to take out the banks from the index, the performance of the ASX 200 would be significantly better.

While I still think having exposure to the banks would be a good idea for diversification and dividends, I would suggest investors restrict this to just one bank. That way any weakness in the sector is cushioned by the rest of the portfolio.

There are other ways to diversify your portfolio as well. Buying a conglomerate such as Wesfarmers Ltd (ASX: WES) gives investors exposure to a number of industries through the one company.

Then there are exchange traded funds (ETFs) which give investors the option of investing in whole indices, countries, sectors, or even themes in a single investment.

With that in mind, two ETFs that I think would be great for diversification are summarised below:

iShares S&P 500 ETF (ASX: IVV)

As its name implies, the iShares S&P 500 ETF gives investors exposure to Wall Street’s famous S&P 500 index. This index is home to many of the largest companies in the world such as Amazon, Apple, Starbucks, and Warren Buffett’s Berkshire Hathaway. While 2020 looks likely to be a shaky year, I expect it to return to form once the crisis passes.

Vanguard MSCI Index International Shares ETF (ASX: VGS)

The Vanguard MSCI Index International Shares ETF is arguably as diverse as it gets. This ETF provides investors with exposure to many of the world’s largest companies listed in major developed countries. This allows investors to participate in the long-term growth potential of international economies outside Australia. Among its largest holdings are the likes of Apple, Microsoft, Amazon, Nestle, and Visa.

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Motley Fool contributor James Mickleboro has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of Wesfarmers Limited. The Motley Fool Australia has recommended Vanguard MSCI Index International Shares ETF. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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