A Fin24 user writes:What does the old expression “don’t put all your eggs in one basket” really mean when it comes to investing? What are the advantages of having a diversified portfolio?
Heather Robertson, a financial adviser and consultant at Blink Consulting, responds:
Diversification is a strategy that can be successfully used to reduce the risks associated with investing.
The strategy involves spreading your money among various investment categories, financial instruments and industries in the hope that if one investment does not perform well, the other investments will more than make up for those losses.
This is because different segments of the economy and market react in different ways to the same event. It goes hand-in-hand with the understanding that it is impossible to predict the future with absolute certainty.
It is important to note that diversification is not always used by investors, but is very useful to those looking to reduce the risks caused by market
volatility, inflation and tax.
To reduce risk and maximise returns, diversification should be done within the following three categories:
Diversification by asset classAsset classes include equities (shares in companies), fixed interest assets (such as bonds), property, cash and alternative assets (such as private equity).
Each of these asset classes delivesr different returns and depending on factors that influence the economy from time to time, no one asset class always
performs the best.
Further diversification is possible across asset classes, for instance equities fall into different sectors like resources, commodities, financials, etc.
Diversification by investment philosophy Different asset managers adopt different investment styles or philosophies. Passive managers believe in simply tracking a market index, such as the Top 40 shares.
Managers who aim to outperform particular market indices are known as active managers.
Active fund managers look at investing in instruments that will offer either significant future returns (a growth philosophy) or investing where the intrinsic value is much higher than the price it can currently be bought for (a value philosophy).
Geographic exposureInvesting offshore provides exposure to different markets and assets not available in South Africa. This allows investors to benefit from favourable market conditions and opportunities in other countries.
- Fin24
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