One cannot overstate the importance of a well-diversified portfolio in any market condition.
The old adage “never put all your eggs in one basket” is the central thesis on which the concept of diversification rests.
Diversification is a strategy that blends different assets in a single portfolio. The theory behind this approach is that the values of different assets can move independently and often for different reasons. The idea is that by investing in different asset classes, if some lose value, the others may increase in value, with a net effect that may either be neutral or positive. A diversified and balanced portfolio will usually contain a mix of equities (shares in companies), government & corporate bonds (loans to governments and companies), property and cash.
Shares move in line with the fortunes and prospects of companies; bonds are most prominently influenced by interest rates; and property values, while also influenced by interest rates, are also more closely connected to the performance of the domestic economy. If you manage to get the right asset allocation, you could make a healthy return, while also protecting yourself against the worst downturns in individual markets.
Diversification requires discipline; the time to do it as at the start of investing and not in reaction to market volatility, as it may be too late by then. A good offence is your best defence. A well-balanced portfolio combined with a 3–5-year horizon (i.e. the period for which you remain invested) should weather most storms.
Here are 5 tips for achieving your diversified portfolio:
Review your goals: Establish what you’re trying to achieve with your investment before starting. What is your goal? It could be a short term goal like saving up to buy a car or a long term goal, like saving up for your retirement. This will determine the types of asset that are suitable for investment. For example, property investment will not suit a short term goal, as it may be difficult to achieve a quick sale if you need some urgent money.
Spread your money: If you are investing in equities (i.e. company shares), do not invest all your money in one company. Instead, invest in a handful of companies. Choose companies that you know and trust and which you use in your everyday life. You can also invest in commodities like gold, in real estate investment funds or in exchange-traded funds ‘ETFs’. Think beyond your domestic market, go global. The more you spread your risk around, the more likely you are to be insulated from a fall in a particular market. However, be careful not to spread yourself too thin by investing in too many asset classes. Make sure you have the time and resources to monitor your investments, so choose a maximum of maybe 20 asset classes to invest in.
Keep building your portfolio : Add to your investments on a regular basis. Apply the principle of ‘dollar cost averaging’; divide the amount that you want to invest and make your investments in small regular amounts over a length of time. This will reduce the effect of any market volatility on the overall investment. It will help to avoid the mistake of making a single lump sum investment that is poorly timed in regards to asset pricing.
Watch the fees : Make sure that you understand the fees charged by your stockbroker or fund manager through whom you are making your investments. Some firms charge a monthly fee, whilst others charge transactional fees. These can add up and may reduce your returns on your investments. So negotiate fees if you have to!
Sit tight, don’t panic: If your investment horizon is +5 years (which part of your investment portfolio should be), and fall in the market (like during this current pandemic), may eventually only be a blip on your portfolio history. Do not be tempted to dump your investments at the first sight of turbulence. If you sell out when the markets fall, you will be looking at losses and will miss out on the eventual upturn of the market (which inevitably always happens).