Why Investing Diversification Lowers Risk

Investment is no longer an alien term to most people. A lot of people have been investing for quite a long time. In fact, people aren’t just involved in trading but various types of investments. Do you know the risks involved with investments? How can you lower the risk with diversification? 

When it comes to investment, it is always advisable to not put everything in a single trade or at a single place. You should diversify your investments and here is everything that you need to know about it. 

 

Why is Investing important?

Investment is a general term that implies saving one’s income for the future and some to face unfavorable circumstances that may arise from unknown future events. It goes without saying that everyone should start investing as early as possible.

You should do some solid research and seek professional advice if needed to invest properly and without risking all of your savings. Diversifying the investment portfolio is one of the smartest things you can do to ensure your money doesn’t go down the drain. 

Always test the water with a leading broker from the below table by opening a demo account with them.

 

What does diversification mean?

Diversification is to divide your money in such a way that even if one of the funds do not perform to your expectations, you would still have your other investments to fall back on.

Investing in various asset classes like equity, bonds, mutual funds, gold, and property will attenuate your risk, and your savings will flourish. So, diversification is all about ensuring that your efforts into saving and investment do not go to complete waste in case a particular strategy doesn’t work out. 

 

Key points to remember here

  • Diversification is a smart strategy being used to minimize unsystematic risk and using multiple investment plans for better returns.
  • There are so many options to choose from. Select the plans that suit your need, and that doesn’t have to be just among the same asset class. You can choose between diversified asset classes and also geographically.
  • You can invest in domestic as well as foreign markets.
  • If you have still not created a smart and diversified portfolio, you are skating on thin ice.

 

How to Make a Diversified Portfolio?

To make a variegated portfolio, you need to spread your cash across assorted asset classes to curtail the risk factor, which is synonymous with market investments. Consideration should be given to Growth and Defensive assets.

1.  Defensive Assets

These assets are as simple as creating FDs (Fixed Deposits) at your existing bank. The returns are quite low, but your cash is safe and sound with a very low-risk factor attached as compared to Growth assets.

2.  Growth Assets

These assets tend to grow your money tree exponentially, but the risk here is greater than that of defensive assets. The investment here is in sectors like shares and properties. The capital gain is lucrative, but the risk attached cannot be ignored.

That is why diversification is suggested by the experts of the trade. They speak in favor of diversification, and the best way to diversify your funds would be to

  • Spread it across several asset classes, for instance, in property, mutual funds, bonds, fixed interests
  • Spread them in various industry sectors, automobile, airline, railway, fashion

The assets classes have some factors that can affect their growth; the main factors are

  • Current market conditions would determine how well a sector would perform. Moreover, its performance will directly affect your investment portfolio.

 

  • Currency and exchange market, the fluctuation here is frequent, and predictions may fall flat many times.
  • Interest rates, too, depend on many factors. There could be a political crisis that can affect the rate of interest being promised to the investors which again affects your investment portfolios.

 

Types of Risks

1.  Diversified Risk

The diversified risk or an unsystematic risk is when the risk could be variegated. In this case, all of your investment would not suffer the same fate in case of unfavorable market events.

2.  Undiversified Risk

Undiversified or systematic risk or market risk. The most common causes are inflation rates, political turbulences, war, and fluctuating exchange rates. Undiversified risks could not be minimized. These risks are to be borne by the investors.

 

Why should Investing Diversification top your list of priorities?

Diversification saves you from the unknown shakedowns of the market. Investment is like rolling a dice game. You may get lucky enough to roll a six, but at the same time, you can either roll a one or consecutive three sixes, which can make you skip a turn in the game. This miss can affect your game.

Similarly, if you put all of your money in one big fund, there could be chances of getting fat returns but can be equally risky, and you may end up losing a lot.

Consider this example for understanding the need for diversification.

Assume you have invested all your funds in stocks of the automobile sector and the workers of the company that you chose to go on indefinite strike. The share price of the company will see a sudden drop, which would inevitably affect the performance of your portfolio, and its value will drop too.

Now consider that you have selected quite a diverse sector to invest, for instance, a part in the automobile sector, a part in real estate, and another section in the airline sector. In this case, if one of the sectors underperform, you still will have some income/profits to fall back on.

 

Investment should be a priority

Higher Returns

The main motive of investing is to make money. There isn’t a set rule of thumb to create an investment portfolio, but as they say, “you reap as you sow.” If you have sown smartly, you will reap good in the future. 

Investors can gain from their investments in the form of capital gain from the real estate sector or can have regular pay-outs from a bond that they opted for. It would be so much better if there is a blend of both.

 

F.I.R.E or Financial Independence Retire Early

This is the new theme that the millennial Z swears by. The movement is huge amongst new office goers. Their plan is simple, work hard, and invest in high returning sectors. 

Although this is not for all, we still want to keep a steady life and fulfill the due responsibilities. For that, we can save for retirement at a regular age. The investment would give a sense of calm and an income to fall back on when you are done with all the chaos of duties.

Tax Efficiency

Many funds give you a tax rebate, or the tax amount is low on some investment schemes. There are many accounts such as RRSP (Registered Retirement Savings Plan), TFSA (Tax-Free Savings Account), etc. The government has enabled these funds so that citizens can fund their own retirement funds.

Beat the uncertainty of the Inflation monster

Money that is kept in a box will lose its purchasing power one day, and inflation would scuzz up the value of your money. A money tree can be created by you if you are investing sensibly. Regular pay-outs on bonds and funds will keep the momentum of life going.

Reach your financial goals with bright sunshine

One of the financial goals that are common to all is to buy a house. A smart investment will aid your speed to reach your financial aspirations.

By investing in a blend of high paying smart plans will make the framework of how your future looks like.

 

Cautions to consider while Investing

Every step and decision that you make in life has a pro and a con. There are so many pros to investments that cons are often forgotten. Take a look at a few cons of investments.

Make sure you pay proper attention to these to keep yourself out of the basic risks. You can ensure that the money that you are putting in actually yields substantial returns as well. 

Be aware of market pattern

There are no “Risk-free” Investment plans available. The degree of risk may vary, but a slight risk factor remains constant. The safest type of investment plans are government policies, but they too have a risk factor attached.

Investment knowledge should be rock-solid

The finance sector keeps on fluctuating, and their policies are evolving continuously. Hence it goes without saying that you should have a sound knowledge of the Market and Investment sector. An experienced investor can cut down on a lot of risk factors from your investment portfolio.

The meaning of investment is different to different people. To some, it is a profit-making idea, and to some, it is to keep a steady growth over time. However, it is done with one intention, which is to meet important milestones in life like buying your first house or raising a financially secure family, or even saving enough for a comfortable retirement fund. Make sure your investments are done in a logical way after analysing all the crucial points and the market as well. 

If you wish to try your hand at trading without putting your money at risk, open a demo trading account at eToro or IC Markets today!