Having a diverse investment portfolio
Diversifying your portfolio provides safety in numbers and boosts your chance of multiplying your investment. Conversely, narrowing your investment to single sectors, industries, markets, or geography dramatically increases your portfolio’s exposure to financial risk.
In short, remember the old saying: ‘Don’t put all your eggs in one basket’.
Also, rather than simply waiting to see what situations and developments pick off the vulnerable elements of your portfolio, there are three areas of risk you can consider and use to modify and protect your holdings:
Systemic or Specific risk
Systemic/Specific risk considers any internal issues such as competition, products and services that fail, bankruptcy, the shape of the market or the price of raw materials affecting your target investment companies.
But it may be hard to quantify due to patchy information on factors such as competition and the shape of the market. Tracking and assessing stock price volatility and industry movements may help assess the risk but will not cover every outcome.
Imagine that you invested $100,000 into a business that ships goods around the world; 99.9% of the time you would expect international shipping/trade to carry on as usual. However, an unforeseen change in the shipping industry or any incident disrupting world trade would be hugely detrimental to your overall investment. However, diversifying your portfolio by investing that same $100,000 into a range of different sectors such as transport, hospitality, and technology, means that when a similar shift in the market occurs, only part of your overall portfolio is affected by specific or systemic risk.
This much broader type of risk is usually observed through monitoring overall changes to the market such as a general economic downturn and recession.
The 2007 banking crisis led to a significant global downturn the following year, bringing major and widespread risk, be it the effects that such a downturn brings to everyday life, de-valuation of assets both physical and intangible, decline in the general perception of the stock market and stock traders, and the public’s (customers’) reaction to such changes.
However, managing your investments through diversification can mitigate potential damage from systematic risk as, even in times of severe economic depression, there are still many businesses that not only survive but bounce back strongly.
So, while one or two of your investments may fail, other investments will thrive during and after a downturn. So, having your investments (eggs) spread across as many businesses (baskets) greatly improves your portfolio’s resilience even if does not guarantee success.
How Do I Diversify My Investments?
Varied industry – you can target invest specific verticals for your investment portfolio, such as tech sectors like Nanotech, Cleantech, AI, AgriTech, or spread the risk on an industry basis through Tech, Energy, Transportation, Aerospace, Mining, Agriculture, or Real Estate. This way, you minimise the effect of poor performance in any one specific sector and decrease potential risk to your investment.
Spread your investment – having 50+% of your entire investment portfolio tied to any one specific business, country or industry is usually riskier for the reasons outlined above. Instead, a good risk-averse investment strategy would be to spread your investments as much as possible: 10-20 companies, each with 7.5-10% of your investment capital tied to them, will form far more resilient and robust investment holdings.
Varied Asset Classes – diversification across various asset classes such as index funds, bonds, equities (private or public) commodities, or dividend stocks lets you grow your wealth over time by balancing risk and reward. This strategy will necessarily vary between individual investors though, as they will typically hold different financial objectives or investment goals.
For example, a less experienced, more brazen investor might focus on high-risk investments such as equities, whilst a more experienced investor closing in on retirement age might choose to shift their focus to lower risk asset classes such as fixed-income investments. Both investors will have a varied range of asset classes within their portfolios; however, their level of investment in one or two of these asset classes will vary depending on their individual situation.
Investors should recognise and accept the risks associated with investing.
Certain investments may require you to keep your holding for periods of many years with limited or no ability to resell unless there is a strongly regulated secondary market.
You may also have limited access to periodic reporting, see your holdings decrease and increase in value, or even lose your entire investment.
Investors should decide for themselves whether to make any investment, basing this on their own independent evaluation after consulting with financial, tax and investment advisors.
The Knowledge Hub does not constitute financial advice whatsoever, but rather provides basic general industry information.