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When investing, it is crucial to make sure you manage the risks associated to your investment or the risk you are exposed to in order to protect your investment from expensive losses.
One of the key elements to any successful investment strategy is a diverse portfolio with a mix of varying assets that makes sense for the level of risk you can expose your self to.
So, what does diversification bring to your investment portfolio?
Diversification.
Diversification is a tactic used by most financial planners and fund managers. It is an investment management strategy that blends different asset investments in a single investment portfolio. Diversification is one of the most common investment management strategies and is brought in for two distinct reasons:
- A variety or range of investment options can yield a higher return in investment.
- A diversified investment portfolio should reduce the level of risk they are exposed through investing in a number of different sectors and asset types.
Risk.
One of the most important elements of any investment strategy is the level of risk you can expose yourself to.
The level of risk you can be exposed to is determined by a select grouping of factors. These include: how much you want to invest, the sector your want to invest in, your investment strategy, the timescale for returns and most importantly the capital you have to support your investment.
Understanding your level of risk is an important component to consider when investing, not only will it provide you with a picture of the potential losses you can manageably accept (swings in the value of your investment), it provides a crucial image of what you can afford in the long-term.
For those who are unsure what risk means for your investment – the greater the risk the greater the chance of receiving higher returns. While lower risk will naturally mean your grown or returns may take longer to materialise.
International Diversification.
Foreign portfolio investment provides investors with a distinct opportunity to diversify their investment portfolio while continue to reap the returns from the assets they invest in. While many would argue that the stock markets is a stressful and overly complicated system, there is a distinct beauty about markets interact across the world. The global stock market operates in such a way that the factors that drive the stock exchange in Germany at any given time are different from those that occur in South Africa.
Not only does international investment provides investors with access to a bigger market base.The interconnected yet diverse markets provide investors with a unique opportunity to diversify their holdings and benefit from similar risk asset returns, however experience less volatility over an investment portfolio.
So how can you diversify your investment options.
There is no golden formula to diversifying your investment portfolio. As investment strategies differ from fund to fund, the best way to diversify your investment portfolio may be different to next. However here are some the options can be utilised:
1. Choose a range of assets
One of the most successful ways to minimise risk while ensuring high potential returns from your investment is to choose a range of assets. Having a mix of assets will help you spread the level of risk of a larger area.
The theory behind this approach is simple, each asset value and performance can move in different ways due to market trends and often for a number of different reasons. Shares move in line with the performance and future of a company, bonds are influenced by interest rates – having a range of assets in your portfolio could not only help you see healthy returns, it protects you against a potentially significant downturns in a single asset class.
2. Diversify by sector or industry.
Diversifying by sector or industry is the natural step from choosing a range of assets. While investing in a range of asset will decrease the level of risk associated with an investment portfolio, this can be aided by diversifying the sectors or industry you are investing in.
Different markets and sectors are not always correlated or related with each other. Once you have chosen the assets you want to include in your portfolio, you can further diversify these further by investing in different sectors.
The theory behind this investment strategy is simple. If you invest in a number of sectors which are not related, if one experiences a downfall a non-related sector should not be impacted and therefore continue to grow in value.
3. Buy shares in a lot of companies.
Now you have chosen your asset class and the industry you want to invest in, it is recommend you invest in a number of companies instead of placing all your eggs in one basket.
If you buy shares in a single company and they bad times/ go bust, your investment will still be at risk even if you diversified across several industries. If you invest shares in a number pf companies, you investment will be far safer if this happens.
