“Don’t put your eggs all in one basket”
This is my mother’s favorite line. When I was little, I grasped it like this: I have to have three wallets so that when one gets stolen, I would not be left with nothing as I still have some spare cash inside the other wallets. Now that I’ve started earning, saving, and investing for the future, I have a clearer understanding of what she meant.
The idea could be as simple as having several savings account to protect your savings, or as complex as diversification.
Diversification refers to a risk management technique that combines a wide variety of investments within a portfolio. The technique is more than just avoiding the loss of money by protecting your investments from market downturns and unanticipated events– the technique also allows you to make more money when investing,
The general idea is a well-diversified portfolio consisted of different kinds of investments, on an average, yield higher returns. You can never know what the market will do at any given moment. That said, it’d be a wise move to allocate your investments among various financial instruments, companies, industries, and other categories, all of which would react differently to the same event.
If you’re looking to build your investment portfolio, then here are seven diversification tips.
- Spread your money
There are four main asset classes you may invest in, namely, cash equivalents, equities (stocks), fixed income (bonds), and alternative investments (real estate, hedge funds, and commodities). Each class is assumed to reflect different risk and return investment properties and performs differently in any given market conditions. Derivatives, or securities that derive its value from one or more underlying assets, like CFD, are also sought by investors.
Why spread your money across multiple asset classes and investment vehicles? Firstly, your overall returns will be less volatile. The losses or significantly low returns from one asset class are offset against the high returns from another. Secondly, you’d be less exposed to one economic event that can easily wipe out your wealth. If one sector you’re investing in doesn’t perform well due to an economic downturn, you won’t lose all your money.
- Diversify within the same asset class
If you’re investing in stocks, why not have a variety of stocks in your portfolio, such as speculative stocks, blue chip, and second-line stocks? You can also consider checking out various types of bonds, like fixed rate, floating rate, or inflation-linked assets.
These can help hedge your portfolio against market volatility and uncertainty, and eliminate your income risk, interest rate risk, and inflation risk. Aside from security, diversification offers growth potential and speculative thrill as well.
- Invest in different industry sectors
Consumer staples (food and beverages, household items), consumer discretionary (durable goods, entertainment and leisure, automobiles), healthcare (medical services, and manufacturers of medical equipment and drugs), financial services (banks, real estate, insurance companies), and industrial goods (construction companies, industrial machinery, tools, and lumber production) are among the sectors to invest in.
Some sectors are more volatile than others, and some perform better at different times. If you buy stocks in various sectors, you may expose your portfolio to grow in different areas of the economy, and it’s less vulnerable to one industry’s decline.
4. Invest in different companies within the same industry sector
Think of investing in different companies in various conditions; small, big, fast-growing, slow-growing, turnaround company, highly-geared, low-geared, and even old companies that still manage to grow. You may have one leading company for larger capital and one emerging company for smaller capital.
A good mix of companies across your portfolio is profitable in such a way that if one corporation does poorly, you can still benefit if the other companies perform well.
- Invest in both high-risk and low-risk assets
The rule of thumb is high-risk assets have higher returns, and low-risk assets have lower returns.
How much of a high risk or low risk you should invest in will depend on your age, goals, risk tolerance, financial situations, and other personal circumstances. For instance, if you’re retiring and you have less time to recoup lost capital, you can increase your allocation to low-risk, fixed income to minimize the proportion of high-risk assets.
- Invest in both local and international markets
Different markets rise at different times; When the US market is down, for instance, the Asian markets may be up.
You can invest in foreign markets directly or through an overseas share option in an exchange-traded fund or ETF, managed fund, or superannuation fund. Just remember that investing overseas could mean increase or decrease in your returns as the Forex rates fluctuate.
- Know when and how to get out
Just because you have your portfolio diversified doesn’t mean you should slack off and let the losses offset against the gains. With great power comes great responsibility, says the wise Uncle Ben; The more companies, sectors, and asset classes you invest in, the more work that has to be put in.
Stay up to date with your investment and watch the overall market conditions. Know what is happening to the companies and industries you invest in.
Author Bio: Sophie Harris is one of the resident writers for FP Markets, a CFD and Forex Trading provider in Australia with over 12 years industry experience serving global clients. Writing informative content about business and finance is her cup of tea.