Diversification: Why variety is the spice of life
Variety is the spice of life. Don’t put all your eggs in the same basket. Diversify, diversify, diversify. If you have the soul of the gambler, then putting all your money in a high risk, high return kind of venture might be appealing. But if you want to make money, having a diversified portfolio is the safest and generally best means of return. Everything comes with risk, but a diversified portfolio is the King and Queen of risk management. Investopedia has a great guide as to the ins and outs of the mathematical models of diversification.
I say this as a portfolio layperson of course. I had share options once, which were administered by a company. I looked at the quarterly report to check whether they were going up or down, which seemed to reflect the meanderings of the stockmarket in general. To me, stockmarkets are little more than numbers in neon dancing over a screen. But the experts tell me, should I desire to save my pennies and get together a nice little nest egg, then I should have a portfolio as varied as the split personalities of the United States of Tara.
A varied portfolio
Can include, among other thing, share, terms deposits, property, bonds, mutual funds or cash. A diversified portfolio can vary across industry, country and asset class. There’s more on different asset classes here. You can have a mixture of high risk and low risk investments, depending on your investment personality. The name of the game is to diversify, so if one area goes belly up, then you’re protected. Apparently this has earnt diversification the title of “the only free lunch in finance”.
First up, get educated. Find a financial advisor you can trust and discuss with them how best to create a portfolio that is both relatively safe and capable of good returns. Talk to the people around you with investments and ask them how they set up their portfolios. While money is still something people feel awkward about discussing, the more information you have at your disposal, the more likely you are to make good decisions.
There are theories and equations involved in diversification that I will never understand, but aiming to be financially literate is the best chance you’ll have to invest properly. It’ll also make the whole process more enjoyable. They’re your well-earned dollars- have some fun investing them. The Australian Security and Investment Commission has some great guides about diversification and risk.
AXA has an excellent blog here, discussing diversification post-financial crisis where the markets distorted in unforeseeable ways. Their conclusion is that a poorly diversified portfolio will underperform. Hence, the key is to have a financial manager that knows how to diversify well. Even if diversification performs less well in stressed market situations, it still smoothes out the rate of return if done well.
We’ve all watched enough movies of people who threw everything into a Sure Thing only to see it evaporate. I’m conservative at heart, but the reward of high return isn’t enough for me to justify the risk. Diversification seems the ticket, at least for my investment personality. After all, I want to find out if there can be such a thing as free lunch.
Do you diversify or concentrate your investments?
We would be interested to hear your thoughts, drop us a comment below.
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