What is diversification?
Diversification means spreading your money around multiple investments. You might have seen phrases like ‘investment diversification’, or ‘asset allocation’, or ‘diversified portfolios’. It’s an important method for achieving your financial goals, whilst reducing investing risks.
Here are four investment diversification strategies to consider:
One: you could buy stocks in different sectors. Buy some in industrial companies, and some in technology firms. You could also buy shares in utilities (people always need water and electricity) and complement these by investing in firms producing luxuries like expensive cars or electronics. Do this and you’ll be partly diversified.
Two: you might invest in different assets. Spread your investment across stocks and bonds, and put money in gold or real estate. You might also dabble in cryptocurrency or other alternatives.
Three: invest in different company types. In boom times, investors might throw money at small start-ups, but during tougher years, they might prefer well-established firms. Put your money in both and you can fend off the worst market fluctuations.
Consider how long you’ll hold your investments. Can you balance your short-term investments with long-term ones?
Four: geography is another route to investment portfolio diversification. Markets in North America and Western Europe will behave in one way, but emerging markets like Brazil or India will do their own thing. A boom in one region can balance out a slump elsewhere.
Advantages of diversification in investing
Diversified investment portfolios can weather short-term volatility. Done right, diversification can help you earn more and reduce your risk of losing money.
Let’s consider some examples. An economic slump might slash the value of jewellery companies and construction firms. However, utilities and consumer staples firms (selling food and beverages) can hold their own during rough times. Invest in both and you’ll make your investments more resilient. Those utilities will stop your portfolio tumbling too far.
Some sectors rise when others sink. If there’s bad news for airlines, such as a long pilot’s strike, airline stocks might fall. That strike would boost railway companies. Buying both airline and railway stocks would help you dodge risk.
If you only invest in one sector, you risk missing out on booms elsewhere. You might be tempted to throw everything into customer staples like food and beverage providers, but what if some new technology earns serious money? Any companies involved could see major rises in their stock prices, and shouldn’t you benefit from that rise?
Diversification makes you more likely to benefit.
Markets go through cycles. They often rise and peak before falling. If you keep your investments fluid, you can invest in a sector which has just had a fall, and benefit from future rises.
This is a complex area, so we recommend speaking to one of our experienced financial advisors to offer you the best diversification advice.
Disadvantages of diversification in investing
Diversification sounds wonderful, but you must diversify in the right way.
You have several questions to consider. What percentage of your portfolio should go into which asset? How much time do you have to plough through a company’s financial report? How can you buy shares in an overseas company? How might you make sense of alternative investments? It all takes loads of research.
You’ll need to keep abreast of market changes. What looks like a brilliant investment now might bring you trouble soon. Make a wrong prediction and your money could vanish.
It’s also easy to miss out on future booms. Developing economies like Indonesia or Mexico might surge, and money you’ve invested elsewhere might give humdrum returns.
Diversifying your portfolio can reduce investment risks, but if you’ve cast a wide net, you might have bought some risky individual assets. You might also pay out a small fortune in transaction costs.
Finally, even diversification won’t give you a cast-iron guarantee against losing money. The 2008 financial crisis saw most stocks fall. Inflation, exchange rates, political troubles, all can cause you grief, even if you’ve diversified well.
But the right advice can protect your money.
Seeking expert advice on diversification
Diversification isn’t a magic potion. A diverse investment portfolio has the power to reduce your risk, and it’s almost always part of a successful portfolio, but diversification needs to be done right.
Its advantages don’t scale well. Go from owning 1 stock to owning 20 and you’ll see benefits. However, if you move from owning 100 stocks to 200, you won’t see much improvement. Your portfolio will be more complicated and will cost more to manage.
Risk diversification means buying different assets, and you’ll need effective advice before buying the right assets.
Speaking to one of our expert financial advisors can help you make the right financial decisions and get investment diversification working for you. Contact us today for a tailored, diversified plan.
