July’s theme for our financial well-being challenge is investing wisely. One crucial element to savvy investing is diversification. Find out how to manage investment risk by diversifying.
What is diversification?
A well-diversified portfolio is absolutely key to a successful investment. But what does diversification actually mean?
There are a number of different asset classes that you can choose to invest in. These include equities or shares, bonds, property, cash, commodities and even artwork, antiques or luxury cars.
Diversification means that you invest in a variety of these asset classes and avoid putting all your investment eggs in one basket. In addition, you can diversify further within each of these asset classes. For example, your equity investments can be diversified across different industries or split between emerging and developed markets. Or you can invest in bonds that mature at different times.
Why is diversification so important?
Diversification is accepted as best practice by most investment experts. In fact, some investment managers claim that how you choose to allocate your assets influences returns much more than your choice of individual stocks or funds.
Investing is a balancing act between risk and reward. Your aim is to maximise your return while minimising risk. This is sometimes called the risk-return trade-off. This will be influenced by your tolerance to risk, which, in turn, is determined by various factors including your age, your investment horizon, your level of wealth and your psychological attitude to risk.
Diversification of investments across different asset classes balances risk because different assets will react differently to various economic conditions. With a diversified portfolio, you can balance out the losses and gains of different asset classes and this is the best way to protect your investments.
Hierarchy of investment risk
In the hierarchy of risk, investments span a wide spectrum, as illustrated in this diagram.
Cryptocurrencies and speculative stocks are the investments which carry the highest risk. These are characterised by significant price volatility and potential for substantial losses. We generally advise against including this kind of investment in a long-term financial plan.
Next comes equities, which offer greater potential for reward but with relatively high risk. Don’t let that put you off investing in stocks. Within this asset class, there is a broad spectrum of risk. Large-cap stocks from well-established companies tend to be more stable and less volatile, whereas small-cap stocks and startups can be highly volatile with the potential for significant gains or losses.
Mutual funds which pool together investor funds to buy a selection of stocks, bonds and other assets are a great way to diversify and reduce risk.
Real estate and commodities fall somewhere in the middle of the risk spectrum with government bonds such as treasury bills offering security with low but reliable returns.
Cash is often perceived to be the safest investment option but returns are paltry by comparison and leave your savings vulnerable to inflationary erosion, leading us to question whether cash is really king.
While so much choice may sound overwhelming, a skilled investment manager can help find the right balance for even the most risk-averse investors. Infinity’s financial advisers partner with the best in the business.
Assessing tolerance to risk
Assessing your tolerance to risk is key when deciding on the allocation of your assets. Most people have no idea how to go about this. That’s where we can help!
At Infinity, our advisers are skilled at helping clients determine their tolerance to risk. Using a combination of expertise acquired over decades of advising expatriate investors, sophisticated software and cashflow forecasting, they will come up with a financial plan that works for you.
You’ll have peace of mind knowing that your portfolio is positioned to generate sufficient return but with protection against the downside. If you stay invested over the long term and ride out the highs and lows that are inevitable when it comes to stock markets, with our guidance you will achieve your financial goals.
If you are interested in finding out more about diversifying your investments to manage risk, make an appointment with one of our advisers across Asia today. An initial chat is free and doesn’t commit you to anything.
A leading provider of expat financial services and wealth management services across Asia.
