Investment diversification is not a new concept. I’m sure that we all know the old saying that you should not put all your eggs in one basket. If a “basket” drops, you don’t want all of your investments to break.
Diversification reduces risk, making the uncertain journey to your financial end-goal significantly smoother.
Investing is an art form, not a knee-jerk reaction. The best time to practice disciplined investing with a diversified portfolio is before diversification becomes a necessity.
Most investment professionals agree that although diversification is no guarantee against loss, it is a prudent strategy to adopt toward your long-range financial objectives.
Here are some insights into diversifying a portfolio:
Limiting yourself geographically will heighten the sensitivity of your portfolio to market swings that affect a certain country or region. Recent events have reminded us that even some of the world’s most elite country’s stability can be questioned from time to time. In building a robust long-term portfolio it is essential to have a good spread of currency and economic exposure.
Global investing comes into its own when there are several growth industries that would not be an investment option if only investing locally.
Tapping into industry sectors
In a similar way to geographic factors being restricting, only investing in gold or only investing in property also causes your risk to go up. To achieve superior diversification you would want to diversify across the board, not only different types of companies but also different types of industries – the less correlation between them, the better.
Being asset-class wise
Your asset allocation will be a major determinant of your future returns and the volatility along the way. Some tactical changes every now and then can be beneficial, but a strategic long-term allocation goes a long way while it is left to do its work.
The basic building blocks are equities, fixed income and cash, and you should aim for an optimum mix which will provide enough growth (equities in the long run) and enough stability and yield (cash and fixed income) to match your time horizon and needs.
Share specifics and credit partners
When it comes to equities, a minimum number of instruments and a maximum percentage per instrument will help to diversify away from share-specific risk. In the same vein, within the fixed income and cash portion there should be a spread of banks and instruments.
If you only own a handful of stocks, or are exposed to very few counter-parties, this will increase your risks.
There is strong evidence that you can only reduce your risk to a certain point beyond which there is no further benefit from diversification. Over-diversifying your portfolio is not a great strategy – if you diversify too much, you might not lose much, but there won’t be much to gain either. After all, you have to be willing to break a couple of eggs before making an omelette.
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