Diversification

Diversification has been referred to as the “holy grail” of investing by billionaire hedge fund investor, Ray Dalio. Diversification is an investment strategy that involves spreading investments across various assets or asset classes to reduce risk. The idea is that by holding a variety of investments, the poor performance of some will likely be offset by the good performance of others, leading to a more stable overall return.

In simpler terms, diversification is the financial equivalent of the saying “don’t put all your eggs in one basket.” By spreading your investments around, you’re less likely to suffer significant losses if any single investment fails or underperforms.

Diversification can be achieved in various ways:

1. Asset Class Diversification: Investing across different asset classes such as stocks, bonds, real estate, and commodities. For example you can have a mix of local shares, regional shares, international stocks, land, treasury bills and bonds, etc. This will help to mitigate losses or risks in one particular asset class. Paper assets are particularly prone to inflation and currency depreciation. One way to mitigate this for high net worth individuals is to diversify across currency and into hard assets. For individuals with sufficient capital consider foreign bonds, foreign currency fixed deposits, mutual funds and equities. Also maintain a portion of your net worth in physical assets like land and property.
2. Geographical Diversification: Investing in assets from different countries or regions to protect against local economic downturns or political instability. For example you can buy stocks or shares in a different country or region to protect yourself from geopolitical risks. It is now very easy to invest abroad using a variety of apps like Chipper Cash.
3. Sectoral Diversification: Investing across different sectors of the economy, like technology, healthcare, finance, and utilities. Different industries face different risks, so diversification allows you to maximize return with reduced risk. For example you can own a goat farm and a supermarket. If one of the enterprises suffers, you can offset the losses using the other businesses.
4. Instrument Diversification: Using different financial instruments, such as equities, bonds, mutual funds, ETFs, etc. Mutual funds, ETFs, Index Funds, and Unit Trusts provide an effective way to achieve wide diversification at very low cost. For example an ETF may hold thousands of equities and bonds across the world which automatically gives you diversification in one go. A unit trust may give you exposure to different treasury bills, bonds and equities.
5. Time Diversification: This involves varying the maturity dates of your investments, especially relevant for fixed-income securities. For example you can have different bonds with different maturities to offset interest and inflation rate risks. You can also use the dollar cost averaging method to consistently invest. This means that you keep investing whatever the economy is doing. When prices are higher you buy less units and when prices are low you buy more units. This is better than trying to time the market.

Diversification does not guarantee against losses, but it does help to minimize the impact of any single poor-performing investment on the overall portfolio.