‘Don’t put all your eggs in one basket. If the handle breaks, all you got is scrambled eggs’.
Diversification is a concept understood by humans for a long time and this is probably true in all aspects of life. A farmer hedges his bets by working on multi-cropping, this helps him reduce the risks of depending on a single crop.
Nowhere is the concept more relevant than in asset allocation, since this is closely related to a person’s long term financial goals.
Consider the case of an investor, who invested only in photographic film company ‘Kodak’. The person would have lost all savings as photography transitioned into digital mode and smartphones. Disruption is the rule of life as Encyclopedia’s are replaced by Google, Travel Agents by online sites, Hotels by Airbnb, Taxi’s by Uber, Cable Television by Netflix and so on.
Forecasting which sector will perform well or fail is an extremely tough task in the 21st century and under this scenario, diversification as a strategy is of utmost importance. Primary benefits of this strategy are minimizing risk of loss, preservation of capital and generation of returns. Diversification is designed to help reduce the volatility of your portfolio over time.
Assets can be classified into different categories such as equities, commodities, bonds & FX (Foreign exchange) and a diversified portfolio means having assets spread across these categories. Certain asset classes perform well under certain conditions and diversification ensures that the investor doesn’t miss out on arising opportunities.
A peek into the current market scenario will help us understand this concept better:
- Commodity prices relative to equities are at their cheapest level in 50 years and even a return to mean will give investor great returns.
- An investor focused only on equities will not be able to capture the returns from commodity markets.
- At the same time global equities are at their highest level in multiple years and any sign of recession in the coming two-three years can result in a big fall.
- Geo-political events like conflict in North Korea or Iran will increase volatility in the markets.
- Investors flock to bonds, gold or a currency such as the Japanese Yen in uncertainty or during market fall as they are considered to be safe haven assets. So bonds are a must have in any portfolio.
It is important to remember that diversification does not guarantee against loss, but helps in minimizing risk and reach long term financial goals.
Founded in 1989, Century Financial has continued to lead the way by offering an extensive spectrum of investment products in the global financial markets for over last 29 years.
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