What is diversification?
Diversification is the simple technique of spreading your investment dollar across different types of assets to maximise your risk-adjusted returns.
Imagine this. You’re eating lunch at a newly opened restaurant with $100 to spend. It’s your first time there and you know nothing about what’s good or not. Chances are, you wouldn’t want to spend all $100 on multiple plates of the same dish, even if it’s their signature dish. Because who knows if you’ll like it.
Even the YOLO daredevils we know would hesitate to spend $100 on 2 types of dishes, because that’s just too risky. If it tastes bad, you’ll end up being hungry, angry, and a food waster.
Diversification is like ordering a spread of various dishes – a selection of appetisers, mains, and desserts. This way, you have a much greater chance of discovering something delicious! The aim is to order more tasty dishes than ‘meh’ ones so that overall, it’ll still be a good, satisfying meal.
In the same way, spread your investing dollar across different types of asset classes such as stocks, bonds, commodities, and real estate. In the event that some of your investments are not performing well, you can balance it out with other better-performing investments to “cover” some of the losses.
Why is it important?
When done right, diversification can reduce volatility while maximising your chances of earning steady returns.
Here are 3 easy ways to start diversifying fast:
1. Diversification is the only free lunch in investment. Cast your net wide!
It’s risky to pin all your hopes on a single type of asset. A company or even industry may be thriving today, but who knows what will happen in the future?
Invest across different industries and markets with little correlation – think healthcare, technology, transportation, renewable energy, for example.
Diversify across geographical locations too!
This is because investments in one country may face the same (good or not so good) factors. Focusing on a single country means being at the mercy of its specific political and economic climate.
2. Include some fixed-income securities
Fixed-income securities provide stability in a portfolio, like an anchor to a ship. As such, government bonds and investment-grade corporate bonds are key in protecting your portfolio against uncertainty in the market.
Best part? You’ll get money from time to time. No kidding. Look forward to fixed interest payments regularly until the bond’s maturity date, where the principal amount is returned!
Want to level up? Try the laddering technique that snowballs your interest! Invest in short-term bonds and collate the steady stream of interest that it gives. Most importantly, set aside that interest instead of spending it!
After the bond matures, gather the returned principal plus collated interest you’ve put aside. Reinvest the total amount into NEW short-term bonds to earn even more interest!
3. But don’t over-complicate it!
While ensuring a variety is important, diversification does not mean holding as many types of investments as possible! In fact, investment experts advise investing in just 5 asset classes.
You might have heard of the 60/40 investment portfolio – 60% allocated to higher-risk assets such as stocks and 40% to more stable fixed-income investments. Such a common portfolio make-up allows investors to benefit from high long-term equity returns while reducing the potential losses caused by fluctuations in the market.
At the end of the day, it’s important to find your own magic ratio. This is because there is no one-size-fits-all solution when it comes to finding the best mix of investment options. It’s all about discovering that balance that fits your objectives and risk tolerance.
Some guiding questions to ask yourself:
- How big is my risk appetite?
- What are my objectives and how much time do I have to invest?
- How experienced or confident am I in managing the different types of investments?
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*Projected yield and returns are not guaranteed or protected