Understanding Diversification In Investment
Without doubt, experts in the investment sector would not hesitate in stating that diversification is the key to successful investing. In fact, almost every successful investors in Singapore set-up portfolios that are broadly diversified. Nevertheless, diversification continues to be underestimated and undervalued by some other investors.
Instinctively, diversification matters. Good investors should not concentrate all their wealth in one form of investment.
Here is a crystal-clear example on the concept of diversification coming from the US Securities and Exchange Commission website:
“Have you ever noticed that street vendors often sell seemingly unrelated products – such as umbrellas and sunglasses? Initially, that may seem odd. After all, when would a person buy both items at the same time? Probably never – and that’s the point. Street vendors know that when it’s raining, it’s easier to sell umbrellas but harder to sell sunglasses. And when it’s sunny, the reverse is true. By selling both items – in other words, by diversifying the product line – the vendor can reduce the risk of losing money on any given day.”
You can find the most important essence of diversification in the last phrase. Diversification means reducing the risk of losing your hard-earned money. Lots of investors in Singapore allege to comprehend the whole thing, but, in truth, that is not the case.
Do you suppose that maintaining 50 stock portfolio can guarantee you with the necessary diversification? The answer is, “no.” No, if all the 50 companies who have released the stocks are found and are operating in the same country and, therefore, are obliged to observe the same laws, policies and regulations and vulnerable to similar socio-political and economic forces.
Do you suppose that keeping your cash in the bank of your choice can safeguard you from losing your money? The answer is, “no,” again. No, in the event the currency depreciates abruptly (yes, you may not “lose” your hard-earned cash in case of currency depreciation but the purchasing power of your money will decline: one of the effects of the global economy, if you still haven’t thought about it).
Do you suppose that having some investment properties can defend you from a feeble property market? No, again. No, if all your properties are of the same kind (e.g. office buildings) and have the same geographical features.
Characteristics of an Extensively-Diversified Portfolio
Normally, an extensively-diversified portfolio demonstrates a modest exposure to certain external factors or events. These factors or events may comprise a wide assortment of things such as the socio-political and economic conditions of a country or as specific as the site or the position of a property.
The problem lies in making out and in mitigating your exposure to these factors or events that may influence the performance of your investments. As a general rule, there are two manners in which you could enhance and perk-up the diversification structure of your investment portfolio.
- Augment the number of investments, or
- Augment the type of investments.
Thus, a portfolio containing 50 stocks is usually less diversified compared to a portfolio containing 5,000 stocks. And the latter appears less diversified compared to a portfolio of 5,000 stocks with consistent allocations to bonds and cash.
Most people usually think that a large amount of cash is needed to build-up an extensively-diversified portfolio. Instinctively, people ask, “ how do you expect to preserve a portfolio of 6,000 companies if you only have a few thousand Singapore dollars to invest?”
The truth is, you can do it easily and without any problem. In this age and time, with a couple of thousand Singapore dollars, it is feasible to own thousands of companies and hundreds of office constructions, residential homes, shopping centres in Singapore and all over the globe. And this is possible via Exchange Traded Funds (ETFs) and Real Estate Investment Trusts (REITs).
And the amazing part lies in the fact that most often it does not cost a lot to take hold of this venture.
Did you learn something from this? You may also want to read “Investment: How to Assess the Value of a Company.”