Portfolio diversification is a crucial principle in sound investing. A well-diversified portfolio involves spreading the investments across different asset classes, sectors, and geographies to minimise exposure to any single risk. It aims to manage risk and minimise the impact of market volatility.
In effect, diversification helps balance out the losses in one area with gains from another. It reduces the potential for severe losses that could occur if all investments were concentrated in a single asset or sector. Diversification helps enhance the consistency of returns while smoothening out fluctuations over time. This leads to more stable, long-term growth of your wealth.
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This is especially important for risk-averse investors or those saving for long-term goals, such as retirement or education. Diversification can protect against unpredictable risks, which affect the entire market and are specific to a company or industry.
Geographical diversification, which involves investing in both domestic and international markets, can protect against regional economic slowdowns. Spreading investments across industries like technology, healthcare, and energy further reduces reliance on the performance of any one sector.
Investing across Asset Classes
Sound investing sense teaches an investor to put their money in different asset classes.
Investment option like stocks offer potential for growth, but come with higher volatility and higher risks. Elsewhere, debt instruments, such as bonds offer moderate risk and moderate returns. Cash and cash equivalents include savings accounts or money market funds which comes with high liquidity but low risk, and therefore, low returns. Real estate investments include properties or real estate investment trusts (Reits) or infrastructure investment trusts (InvITs). Real estate investments are tangible, but is highly illiquid. Commodities like gold, silver, and oil move differently than stocks. Alternative investments include hedge funds, private equity, and cryptocurrencies.
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Diversifying Within the Asset Class
Diversifying within an asset class means spreading your investments across different options in the same category to reduce risk. For example, in stocks, one could consider investing in different sectors, company sizes, and countries. In bonds, one can mix short- and long-term bonds from both government and private issuers. For real estate, one can choose various property types and locations. With commodities, the investment can be spread across metals, energy, and agriculture. Even with cash, one can use different savings tools, such as fixed deposits or money market funds. This way, if one investment underperforms, others can help balance your returns.
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Domestic Vs Global Assets
Domestic investments are easier to understand, follow local rules, and may have lower risks related to currency or politics. They support the local economy and are often more familiar to the investor.
Global investments offer access to more opportunities and industries, especially in fast-growing or stable markets outside your home country. They also help reduce risk if your national economy faces trouble, as other regions might perform better at the same time.
Investing in both helps balance your portfolio. Domestic investments provide stability and familiarity to your portfolio, while global ones offer growth and diversification. Together, they create a stronger, more flexible investment strategy.
