Diversification simply means that you should not put all of your investment eggs in one basket. Many people put all of their money in mutual funds, others put all of their money in 401k plans, others use all of their money to buy gold – all the aforementioned scenarios could be termed as investments but they are miles away from smart investments. Diversification encourages you to invest, but it encourages you to take investments a notch higher by putting your money in lots of different kinds of investments.
This article seeks to intimate you with some reasons you need to use more than one investment vehicle for diversification.
Investments don’t perform at the same rate
The first reason you need to use more than one investment vehicle to diversify your portfolio is that investments do not all perform at the same rate at the same time. There’s never a perfect market scenario in which all types of investments will record the same amount of gains/losses at the same time. There will always be gainers and losers in the market. More so, investments tend to outperform at different rates; hence, you will always find top gainers and top losers in the market.
Hence, putting your money into different investment vehicles ensures that you are making money on some investments even if other investments are losing money. For instance, at the start of this year, equities started on a weak not but gold enjoyed strong tailwinds to deliver more than 17% gains in the first quarter. Investors who have both stocks and gold in their portfolio might have lost money on stocks but they would have recovered the losses from the gains recorded in gold.
Investments are influenced by different factors
The second reason you should use more than one investment vehicle for diversification is that investments are influenced by many different factors. Factors such as peace pacts, wars, geopolitical tensions, natural disasters, interest rates, inflation rates, and exchange rates affect different investments to varying degrees.
During the global financial crisis of 2007/2008, many stock investors saw the value of their investments evaporate from millions of dollars to thousands of dollars within a couple of months because everybody was dumping stocks and nobody wanted to buy. Many of those who had all of their investments in stocks are yet to recover from the losses sustained in that market crash.
Likewise, precious metals tend to appreciate in value when the economic outlook is uncertain or when geopolitical tensions are boiling. However, stocks and bonds tend to rally higher when the economic outlook is buoyant and the central banks are making moves to raise interest rates.
Diversification minimizes risks and maximizes returns
Investment generally involves taking risks because you could lose a part or all of your investments if you end up on the wrong side of a trade. Savers are on the safer side (pun intended) because the money in their bank account will remain intact even though its value might diminish because of inflation. However, investors understand that putting money in low-risk investments will bring low returns while putting money in high-risk investments will bring high returns.
However, some investors often make the serious mistake of putting all of their money in low-risk investments or putting all of their money in high-risk investments. If you diversify your investments, you can easily have a mix of low-risk conservative investments and high-risk speculative investments. Binary options is a good way to start investing in speculative investments, you should also consider option contracts, and futures as speculative plays.
Here’s a basic guide to diversification
If you are interested in having a diversified yet balanced portfolio, you might want to use the guidelines below to determine the assets in your portfolio.
- You should have a mix of speculative and conservative investments. Speculative investments are binary options, futures, and forex – conservative investments include gold and stocks of blue-chip companies.
- You should diversify within the same asset class. For instance, you should have forex pairs with different exposures, binary options with different expiries and payouts, and stocks in different sectors of the economy
- You should hold a percentage of your investment as cash or highly-liquid investments that you can convert into the cash at a moment’s notice
- You should learn the principles of asset allocation and ensure that your investments reflect your risk appetite, age, and investment capital.