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Diversification as a tool for reducing risk

- Don't put all your eggs in one basket –

By Nico-Louis Minnie - Investment specialist at Liberty Life

Don’t put all your eggs in one basket, is an old saying yet sound advice. But what does this actually mean? It means that you need to spread your risk across a variety of asset classes for example, cash, equities, bonds and property. When you start investing the amounts you have to invest are usually small, so you are probably better off buying into just one share, as the cost of multiple purchases would be prohibitive and costly at the start up stage. But as your portfolio grows over time you will need to consider diversifying in order to reduce your risk.

Nico-Louis Minnie, an investment specialist at Liberty, sums it up best, "Not putting all your eggs in one basket means to spread your risk or to diversify. For example, if you invest all your money in Anglo (a mining house) and they have a bad year, you will lose money, but, if you invested in Anglo and 20 other companies, you are less exposed to any one specific company and hence your risk is reduced. The same argument applies to diversifying across equities (shares), cash (money market), bonds and property – if one of these asset classes performs poorly, you are still exposed to others that are better positioned to provide a return."

Each option offers a different return and risk variance. By having a diversified portfolio, you could achieve a better overall outcome in the long term.

It may sound extremely complicated but the process really is simple to grasp. You start with savings (remember every month we save - then we spend), and over time as your savings grow, you use a portion of that money to start a share portfolio with a first share purchase. Once your portfolio has grown, you are then able to diversify, by buying into a different industry. Now, you're well on the road to diversifying; you've got cash (your savings) and different asset classes, hence a diversified portfolio.

Minnie comments that there are even easier ways to diversify, "Diversifying across shares is easiest when investing in an index fund that represents the equity market in general. Diversification across asset classes could be achieved by investing in a balanced fund where the asset manager is tasked with diversifying asset class exposure." So hey presto, one index or balanced fund and you are instantly diversified and your eggs are scattered across different asset classes and industries.

Then when markets get crazy, like we have seen in recent years, you’ll be less at risk. Sure, we haven’t removed the risk completely, but we don’t want ‘no risk’ as no risk, means no reward.

Whether you are new to investing or a seasoned investor there are a couple of investment principles that you need to keep in mind before deciding on the right investment for you. You may think that investing in the stock market is complex and only for the more mature folk however; through the assistance of an accredited and registered Financial Adviser (FA), you can learn how to become an ’investment guru’ even in a down market and irrespective of your age. 

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