Diversification for any business, company or individual is critical in minimising risk. Instead of ‘carrying all your eggs in one basket’, it is better to have several baskets, so if one basket gets dropped and the eggs break, there are still other baskets with safe and secure eggs available.
Wealth consultants must provide investors with a good diversification management strategy to mitigate the risk of losses on their wealth-building journey by spreading their stock, assets and investments over diverse areas.
You can spread the risk of your investments in various ways to avoid heavy losses to your capital and encourage growth. Diversification is not just about avoiding losses but also gaining as much growth as possible, whether on new or long-term investments.
Asset classes are collections of similar investments that also behave similarly in the market.
To benefit from diversification, you need to invest in assets that behave differently from each other. Different assets have negative correlation to each other, meaning when one loses value, another increases in value.
Asset classes - asset allocation refers to the process of dividing your investment between different asset classes such as Cash, Bonds, Shares/Stocks/Equities, Property etc.
Cash/money market – These funds are invested in cash and short-term deposits. They generally achieve a better rate of return than savings accounts and bank deposit accounts. (These are usually the lowest-risk assets)
Bonds/fixed income – Investors consider these stable, low-risk investments. Bonds are issued by companies and governments to raise money. It is, in essence, a loan with a predetermined payback day and fixed amounts paid at regular intervals.
Shares/Stocks/Equities - These are shares of companies traded on the stock market. This type of investing is higher in risk, but returns are generally higher. Money is made when stocks or shares increase in value or when dividends are paid to shareholders.
Commodities and property – Tangible or physical goods traded, like precious metals (gold, silver, platinum, palladium etc.), agricultural produce (wheat, maize, coffee etc.) and minerals like crude oil. Property usually refers to commercial property investment. This is investing in real estate companies or buying properties to generate rental income.
Alternatives – These do not fall into regular asset class categories such as hedge funds, venture capital, cryptocurrency etc.
This means investing in a variety of industry sectors to spread risk, e.g. the financial sector, like banks and fund managers, the telecommunications sector, like Huawei, the property sector, energy sector, like solar companies or utilities, information technology, like Microsoft or Alphabet, healthcare and pharmaceutical companies, and consumables like cereals and beans, to name but a few.
This will help mitigate the risk if one of the sectors performs poorly.
Different economies are affected by different factors. It seems logical to spread your risk over several economic regions. e.g. US markets, Asia markets, Europe, UK markets, Emerging markets etc.
This means investing in companies based in different regions or different stock exchanges like the Nasdaq, FTSE, S&P etc.
This approach invests in stocks/assets of companies operating in various market sectors and based in different regions, e.g. Google, Microsoft, Credit Suisse, BP, Alibaba, Toyota, Huawei etc.
There is also the possibility that you could over-diversify your business or personal portfolio in an attempt to ensure diversification. It might not cause you to lose money, but it may be holding back your capacity for growth.
Also, consider the time factor of your investments – long-term investments could be invested in different funds to short-term investments. Some funds perform better over the long term, so using them for short-term investing might not deliver favourable returns.
Whilst diversifying your investment portfolio can be confusing, it is always best for investors to seek the advice of a deVere financial expert to advise on the best investment strategy according to your risk appetite and individual financial circumstances.