Initially I was hesitant to begin investing because I always heard from people that it was very risky. However, I learned that these risks can be tackled. Taking action to mitigate your risks is an essential part of investing, and one every investor should consider when managing their portfolio.
In the arena of investing, the terms ‘bull’ and ‘bear’ may be as familiar to you as your morning coffee ritual. These Wall Street metaphors are your companions on your financial journey. The bull, a symbol of strength and vigor, represents rising markets, while the bear, indicative of a cautious approach, represents falling markets. But how do you balance riding the bull’s energy with dancing gracefully with the bear?
The answer lies in two words: portfolio diversification. The process may seem daunting, but as the legendary investor Warren Buffet once said:
“Risk comes from not knowing what you’re doing”
Warren Buffet
So, let’s get to know how we can diversify our portfolio and mitigate those risks, shall we?
Understanding portfolio diversification
Firstly, let us clarify what diversification means in the world of investing. Picture a well-balanced meal with all the right proportions of proteins, carbohydrates, fats, and essential vitamins. Just as our body requires a varied diet to function optimally, a healthy portfolio benefits from a mix of different investment types – stocks, bonds, commodities, and more – to withstand the rigors of financial turbulence.
If you do not happen to have a crystal ball to predict which specific investment will perform best, spread your bets across a variety. If you like to invest only through stocks for instance, you can benefit from spreading your investments across segments or an entire index.
Implementing diversification
Let us look at how you put this idea into practice, and what options you have to diversify your portfolio.
Asset allocation
To many investors this is a primary step to diversify your portfolio. Asset allocation involves dividing your investments among different asset classes like stocks, bonds, and other alternatives (like commodities or real estate). Each asset class has a different level of risk and return, so each will behave differently over time.
For example, imagine you are playing on a financial seesaw. On one side are stocks, with high potential returns but significant risk. On the other end are bonds, offering more modest returns but with a lower risk profile. By having a foot on each side, you can balance your financial seesaw.
Diversify within asset classes
This strategy involves spreading your investments within a particular asset class. For instance, with stocks, do not just buy tech stocks. Consider other industry segments as well, such as pharmaceuticals, transportation, banks, etc.
Let us take a hint from the Oracle of Omaha, Warren Buffet. His conglomerate, Berkshire Hathaway, has investments across sectors: from tech giant Apple to insurance stalwart Geico, from multinational conglomerate 3M to food major Kraft Heinz. He does not put all his eggs in one industry’s basket.
Rebalance regularly
Think of your investments like a garden. Just like a gardener has to regularly trim plants to keep the garden healthy, it can be beneficial to adjust your investments from time to time. This is called ‘rebalancing’.
How does this reduce risk? Markets can change quickly. Sometimes, certain investments (like stocks) might grow a lot. If stocks become too large a part of your investment ‘garden’, it can get risky because stocks can also drop quickly. So, by trimming back (selling some stocks) and planting more of something else (buying other types of investments), you keep your ‘garden’ balanced and manage risk.
Diversify the Jack Bogle way
Late Jack Bogle, the founder of Vanguard Group, championed the idea of low-cost index fund investing. He believed in the power of diversification coupled with the discipline of ‘buy and hold’. By investing in a broad-based index fund, like the S&P 500, an investor inherently diversifies among 500 largest U.S. publicly traded companies. This approach, though simple, has shown remarkable success over decades and is a testament to the power of diversification.
In conclusion: diversify to keep your bears and bulls in balance
Diversification helps you reduce risk by spreading your investments across various assets, industries, and even geographical regions. While it does not guarantee profits or protection against all losses, it is one of the most robust risk management strategies an investor can employ.
So, get ready to embrace diversification, and ensure your portfolio is well-equipped to dance with the bears and charge with the bulls.
Always make sure that your diversification aligns with your investment strategy.
