A useful tool for managing risks and rewards

Disclaimer: The information in this article is not intended as, and should not be construed as Financial or Legal advice. All investment and financial opinions listed below are from the personal research and experience of the writer. You should not make any financial, investment, nor trading decisions based on the information provided in this article.

Diversification

Diversification is an investing technique that reduces the risk of your portfolio by allocating investments among different industries and financial instruments. This practice spreads out your investments, hence limiting the risk exposure of any one type of asset.

This practice optimises returns by investing in a variety of sectors, each of which should react differently to market movements. Diversification helps to reduce the volatility of your portfolio over time. This investing technique does not guarantee against loss, but it does minimise risks in a bid to reach long-term financial goals.

To achieve superior diversification, do not simply invest in different companies, but invest in different types of industries. The lower the correlation of your assets, the better.

Different Asset Classes

A well-diversified portfolio would include different asset classes. Market diversification should occur at various levels — within asset classes and between asset classes.

Different assets such as stocks and bonds do not react similarly to adverse events. This hence reduces your portfolio’s sensitivity towards market swings. Equity and bond markets move inversely, so any downtrends in one area would be offset by uptrends in the other.

Stocks

Stocks are the most aggressive assets, with the potential for larger long-term growth. This greater potential hence brings around greater volatility and risk in the short-term.

Bonds

Bonds provide regular interest incomes and are much less volatile than stocks. Bond investors have to accept lower long-term gains, but in return will undertake lower risks. However, do note that high-yield bonds and come international bonds to offer higher returns, along with more risks.

Cryptocurrency

Cryptocurrency is gaining traction and has been getting adopted among investors recently. FinTech companies are slowly buying up and using cryptocurrencies, while companies like Tesla, Amazon and Expedia accepting Bitcoin (BTC) as payment. The government of El Salvador has even made it legal tender in the country.

Price correlation between stocks and cryptocurrencies is close to zilch. As such, the crypto market is unaffected by the stock market, and vice versa. By allocating a small percentage of your holdings to this asset class, you can improve your diversification. However, this also means undertaking more volatility and risk.

Baseline

To invest successfully, you have to learn how to balance your comfort level with risk against your time horizon. Find the balance between risk and return, and you can dabble in the stock market whilst still sleeping peacefully every night.

Alexander SR Pang