Investments come in many different forms and although there is no simple equation that can turn every investment into a success, there are things that you can do to increase your chances of experiencing returns.
“To have diversity in your portfolio, you need things that behave differently in different circumstances” – Mike Coop, the head of multi-asset portfolio at Morningstar Investment Management
This quote underpins the very meaning of diversification but what does it truly mean?
What is the Meaning of True Diversification?
With every investment comes risk but the aim of any investor is to reduce that risk by ensuring that your investment asset is split up. This can then be spread out in a range of ways.
The first meaning of true diversification relates to investing in countries. Economies are very volatile and investing in one country alone is a risk that is not worth taking. Therefore, it’s always worth investing in several economies because as one economy might slow, another one might grow rapidly, helping to offset the losses of the underperforming economy.
Investing in industries works in much the same way as investing in economies as one industry can underperform while another might grow at an impressive rate. Of course, it’s challenging to predict how industries might perform in relation to supply and demand, regulations introduced by governments and the economic outlook. Therefore, investing in multiple industries will help to reduce the risk, while not relying on one specific industry to grow.
There are many other vehicles that you can use for investment and it is not just about industries and economies. It’s possible to invest in the likes of cryptocurrency, gold, oil and even diamonds, all of which are their own independent investments and behave differently from one another. If you use diamonds as an example of diversification, they offer greater value because of they in which they move independently. This means that they are not influenced by external factors such as the behaviours and movements of investors. Along with this, Diamonds sit outside of many equity markets which means that they are not susceptible to the same volatility of gold.
It’s worth noting that there is no such thing as the perfect investment. You might opt for government and corporate bonds that can provide a stable return but low rates can limit the amount that your investment will grow. There are always stocks that can create more dividend and capital appreciation but they are more susceptible to fluctuation. With the likes of diamonds, they are an investment that you can physically own yourself and the price is not driven by a collective mentality, so it’s really important to consider all investments within your portfolio.
So, diversification is a way of spreading your investment assets to avoid holding everything in one place. Therefore, the one thing to consider is correlation. This is a term that is a statistical measurement that determines how investments move in relation to one another. Therefore, it is measured on a scale of -1 and +1. As a result, the aim is to consider all of your investments and how they perform alongside each other. If one is underperforming the others should help to keep your portfolio growing or stable. What this means is that careful consideration has to be made to the investments that you make.