Investment Diversification: Because A Single Dish Is Rarely Sufficient
Imagine visiting a restaurant and being graced with a spread curated by a Michelin star chef; you’ll be spoilt for choice. An impressive, intimidating menu full of dishes you probably are clueless about but still excited to taste them. Investment diversification works much the same way.
Throughout life, we’ve been accustomed to have plan A to Z because being reliant on one option may sometimes not end well. Diversification is about cushioning for different outcomes; the negative ones especially, not predicting a perfect result.
At its core, investment diversification is the practice of spreading your investments across different financial assets instead of pooling all the money in one. Remember, it’s doesn’t end at spreading the money but also having right mix of assets. With a few thousands on you, it wise to allocate the money in different assets but of course bearing in mind your investment preferences like risk appetite, time horizon and financial goals to help you navigate the market confidently.
A common misconception to clear up, diversification isn’t investing in many versions or accounts of the same asset. Yes, you’ve spread across the assets but it’s the same asset susceptible to the same factors, which means in unfavourable conditions you can be guaranteed of a massive loss. Owning multiple assets of the same asset exposes you to the same risks, known as concentration risk. Same body, different outfits.
Disclaimer: Investing in all financial assets carries risks, and past performance (empirical data) is not indicative of future results. Make sure to do your own due diligence and if you prefer can consult with a financial advisor to guide you before making any investment decisions. Be sure to confirm you are dealing with a registered and approved financial advisor and don’t share your personal details; security details included.
The aim of diversification is to reduce portfolio risk by combining different assets that respond differently to market conditions.
With that said, how can diversification be done in a beneficial way to reduce your portfolio risk?
Practical ways to diversify your portfolio
Across different assets
You have options of financial assets in the market that cater to different risk profiles.
- Equities: Fluctuating market rates, higher return potential
- Fixed income (e.g. bonds): Can be capital intensive offering more stable cash flows/returns with exposure to low risk
- Real estate: Rental income or the real estate investment trusts (REITs), with no tenants to chase, pay dividends and capital appreciation
- Collective investment schemes (e.g. MMFs): Low risk, low returns, suitable for conservative and risk averse investors.
- Over time
Trying to time the market can easily be a full-time job. Instead, you can maintain a regular investing habit which spreads your money across market high and lows. In the long run, your consistency snowballs to an avalanche of meaningful returns.
Across economic sectors
Industries respond differently to market/economic cycles. Some investors gravitate towards innovation and technology, environmental-friendly and sustainability pro sectors. Such options are accessible especially through stocks investing.
Diversification by sector helps reduce heavy reliance on single industry success because even high performing sectors have off days.
Beyond borders
Both local and offshore investing are more accessible to investors through some regulated stockbrokers and financial institutions. Although offshore investing can be an expensive venture it may still be beneficial. Investing in different currencies also counts for example USD-denominated unit trusts can offer additional layer of protection.
Real Value of Diversification
For clarity, it’s important to know diversification has its limits:
- Because risk is reduced it doesn’t guarantee profits
- It doesn’t mean no losses. For example, stock market fluctuations
- It’s not a promise that every investment will perform well
The true value of diversification is embedded in patience and consistency. Longer term portfolios are rarely built by the most adventurous or highly risk loving but by those who stay invested, rebalance the assets and allow time for growth. Diversification represents a quiet, calm confidence that amidst market uncertainties, the portfolio will stand firm and adapt to the shifts.
Simple approach to building a well-diversified portfolio
- List your short, medium and long-term financial goals. It defines your time horizon.
- Assign amounts to each goal. This will help determine the amount and frequency of the deposits.
- Assess your financial capability if you have funds to channel to your portfolio (I know it’s ideal to save then spend but, in all honesty, you can’t invest on an empty stomach, Eat first!
- Understand the assets in the market. Useful tools you can use:
- A list of the assets, decipher the structure and performance to see how it can cater to your financial goals.A financial calculator, you can use the one available in this website here – financial calculator.
- Guidance from an educator, coach or advisor. Don’t struggle, contact me asap!
Focus on the structure and function of each asset. None is better than the other since they serve different purposes.
- Open the accounts and begin or continue to grow your portfolio towards your goals.
- Stay consistent with your contributions, this is where the magic happens.
Parting shot
Build a robust portfolio that can withstand storms happening in another facet of your life. When you organise your finances, they become a valuable support system and cease to be a source of stress.
Best wishes on your financial journey.