Why does it pay off to diversify your investments?
As the old saying goes, don’t put all your eggs in one basket. In the same way, it’s important that your investments aren’t concentrated in just one area. Diversifying your investments mitigates risks.
Why does diversification matter?
In investing, the risk is the greatest when you make a single equity investment, concentrating all your assets in one instrument. Diversification aims to mitigate the risks involved in investing. If one investment instrument generates a poor return, another will perform well, thus compensating for the former in the overall value of the portfolio. Diversified investments generally have a lower risk than if they are not diversified.
Diversification is also an integral part of target-oriented saving and investing, as it makes it easier for you to predict the return, risk and performance of your portfolio in the long term. Investors often feel that losses impact their finances more than profits, and here diversification also matters, as it can help you limit losses. You won’t be able to avoid losses generated by any individual assets but diversification can help limit their impact on your portfolio.
So what’s the best way to go about it?
- If you choose to make direct investments in equities or fixed-income investments independently, you will also need to ensure that your investments are well-diversified.
- If you invest in funds, on the other hand, the fund company will pick the investments in the fund and make sure they are well-diversified on your behalf. All you need to do is to choose how much risk you are willing to take. Based on your risk level, your bank’s investment adviser can help you select a matching fund to invest in.
What mainly determines the return and risk of a portfolio is the mix of equities and fixed-income investments in it. A well-diversified portfolio consists of both. If the value of your equity investments drops, certain fixed-income investments, such as government and corporate bonds, may perform well and help preserve the value of your portfolio.
Diversify through monthly saving
Monthly saving is an excellent way to mitigate the risks in your portfolio. However, this works best when you have a steady stream of monthly income (such as salary or rental income), some of which you can invest. If you leave your money idle in your bank account until the next month, you could miss out on potential returns if the stock prices rise in the meantime.
Spreading investments across regions and sectors and over time
It’s good to keep in mind that you should spread your investments across various regions and sectors as well as over time. Since the financial crisis, the North American market has clearly outperformed Europe, for example. The shares of companies in the materials and consumer discretionary sectors also generate returns at different rates.
When you spread your investments over time, for example through monthly saving, you ensure that you invest gradually and with a long-term approach. It also allows you to even out the effects of market fluctuations on your investments.