Aug 3, 2023
 in 
Investing

Diversification: An Investment Feast

I

magine you’re planning a grand feast for your friends and family. You want your meal to be one that everyone enjoys and remembered for years to come, immortalised forever on social feeds! You decide that instead of settling on a single dish, you're going to serve up a smorgasbord of delicious dishes from various cuisines that your multicultural group will appreciate.  

You choose a sumptuous Italian pasta, a tantalising Emirati tharid, a spicy Indian curry, a perfectly grilled American barbecue, a refreshing Thai salad, and a creamy French soup. Each dish represents a unique flavour, texture, and culinary experience, and your menu has catered for a range of preferences and dietary restrictions.  

The evening is a wild success. Everyone raves about the wonderful selection of tastes and having something available that they could enjoy. Well done, you!

Now, you may be wondering what this feast of flavours has to do with diversification in investing? We won’t leave you hungry for answers. (See what we did there? 😉)  

Like the varied dishes on your dining table, diversification in investing involves spreading your money across different assets. By having a range of meal options available, you mitigated the risk of anyone going hungry for lack of choice or preference. A diverse investment portfolio applies a similar methodology.  

Let’s dig in, shall we?

Diversification in investing: a recipe for success?

Why diversify your investment portfolio?

The primary goal of diversification is to mitigate risk by reducing the impact of unfavourable performance of a single asset or specific sector. By spreading your investments across different asset classes, industries, or geographic regions, you can avoid over-reliance on any single investment, and create a more balanced and resilient portfolio.  

Here’s how diversification helps.  

Risk mitigation  

Different stocks are going to respond differently to market conditions and economic situations. Some stocks might underperform, while others may hold steady or show positive returns. A balanced approach can help reduce the overall risk, as your overall portfolio performance isn't solely dependent on the performance of a single asset or asset type.

Enhanced returns  

Diversification not only reduces risk, but also opens doors to potential investment opportunities. By investing in multiple assets, sectors or geographic areas, you can position yourself to benefit from different market cycles, increasing the likelihood of favourable returns.

Healthier mindset  

Volatility and uncertainty are part-and-parcel of investing in the financial markets. A well-diversified portfolio can help alleviate any potential emotional strain associated with extreme market fluctuations, providing peace of mind to investors during turbulent times.

Now that you know why diversification is so important, let’s look at the practical side of things; how to go about doing it!  

5 simple strategies to diversify your investment portfolio

1. Allocation

A crucial step in diversification is deciding how to allocate your investment capital. The allocation should align with your financial goals, risk tolerance, and the amount of time you have to invest.  

2. Geographical diversification

Investing in different geographic regions can further mitigate risk. Global economic conditions and geopolitical events can impact specific regions differently, making international exposure a valuable aspect of diversification.

3. Industry diversification

Industries can experience varying levels of growth or contraction depending on market conditions and economic situations. By investing in a mix of sectors, investors can shield their portfolios from downturns affecting specific industries.

4. Ethical or values-based diversification  

Invest in something you love! If you want to ‘put your money where your heart is’ based on your personal ethical code, beliefs and values, why not consider diversifying your portfolio across businesses tackling the issues you care about most.  

5. ETFs for ‘instant’ diversification

ETF is short for Exchange Traded Fund, with a fund being a collection of stocks based on certain criteria. They may include a range of companies within the same sector, a broad selection of the top stocks from a particular exchange or country, or a variety of asset types. The most loved ETFs usually mirror a widely known index, such as the S&P 500, for example and are great for ‘instant’ diversification as they include a pre-selected spread of assets and are generally a cost-effective way to maximise exposure with minimal effort.

Note: When investing in an ETF, you’ll own a share of the fund (your money is pooled with others’) and not the underlying assets.  

Afters

Diversification is the backbone of an effective investment strategy, designed to protect you – and your capital - from the inherent uncertainties of the financial markets. By spreading risk across various assets, sectors, and regions, diversification can help to increase the potential for sustainable returns and provide a better sense of security, even in the face of market volatility.

Remember, successful investing is not just ‘what’ you invest in but also ‘how’ you invest – and diversification is a key ingredient in your recipe for investment success.