As finance professionals have probably read thousands of times before, “We live in a digital landscape,” often as a segue into how complex managing investments has become thanks to technology. However, it’s never just been technology that’s making investments more complicated. It’s an era of rise and fall, with investments becoming trickier with how chaotic modern life has become.
The dream of a “stable” portfolio hasn’t exactly gotten simpler. Sure, it may be stable now, but these days, the safe investment can just as quickly fall by the wayside. That’s why diversifying your investments and thinking ahead of the market is key to long-term success. However, some new investors may not even realize what “diverse portfolio” actually means, past being used as a buzzword by marketers trying to sell their stocks.
What does it mean to diversify your portfolio?
To put it simply, diversifying one’s portfolio means having multiple investments across different niches, industries, and companies. As for why people diversify their portfolios, it’s essentially a “safe” way of investing to ensure that they aren’t “exposed” to the market or a lack of finances. In investment terms, exposure means the risk of losing profit on an investment.
Compare a person carrying two buckets half-full of water versus another person carrying a full bucket of water. In literal value, they have the same amount of water. However, if someone bumps into the person with two buckets of water, it’s unlikely to spill. Meanwhile, the full bucket will lose a significant amount of water. In this scenario, a diverse portfolio represents the person with two buckets.
Why a diverse portfolio promotes long-term growth
Of course, a “diverse portfolio” is rarely as simple as having two buckets. Investors have to think bigger than that to truly appreciate the value of a diverse portfolio. Why not bring a car for the two buckets instead of walking? What if instead of carrying two buckets, get eight half-full buckets and hire four people to carry them to wherever it’s needed? Diversity isn’t just about having different investments, it’s also about keeping those different investments as safe as broadly possible.
The effects of a diverse portfolio are easily observed, even by studies. According to Ahmadu Bello University’s Department of Mathematics, those who diversify their portfolio are mathematically more protected from risk, provided they plan properly. Still, understanding the value of a protected portfolio is one thing, but achieving it is another.
The best ways to diversify a fund portfolio
Diversifying one’s fund portfolio varies incredibly per person, let alone per country. Everybody has situations unique to themselves, meaning there are no “safe bets” that will work for every single person. More important than what to invest in is learning how to invest.
The “what” to invest in will change like the tides, but the core of how to invest will remain remarkably consistent, regardless of era.
Know the math (or someone who does)
Math is an incredibly powerful tool for choosing investments. From top to bottom, every aspect of investment has some percentage or value associated with it. These decisions will influence the profitability of each investment. Investors will want to have a portfolio with a foundation in mathematical truth.
In short, investors cannot just invest in “vibes.” For those with a background in the math of finances and investment, it’s time to put it to good use. Otherwise, people can either learn themselves or hire a fund administration expert who does. Investing from a position of proven data makes a diverse portfolio that much safer.
Asset correlation
A common trap that many fresh investors fall into is “diversifying” within the same group of stocks. For example, the NFT trend saw many investors “diversify” their portfolios by investing in different NFTs. Unfortunately for these newbies, the cost of most NFTs was homogenous, meaning when one NFT drops in value, many follow. By 2023, 95% of NFTs were practically worthless.
While an extreme example, it showcases asset correlation in action. Although some companies may seem different on the surface, they may adhere to the same rules. That means problems that arise for one will inevitably pop up for the other. Diversifying means more than just different companies or even products. Take a good look at each industry and make decisions based on their stability.
Understanding risk-reward
Risk and reward are at the very core of investing. No matter the investment, there’s always the danger of losing it all. One’s attitude towards risk reward depends entirely on their goal. Investors looking for fast profit may want to lean towards mid-to-high-risk investments, with a few low-risk for stability.
Those who have the patience or are prioritizing a retirement fund may want mid-to-low-risk investments across the board. Tech-savvy investors may even use AI to optimize risk analysis to further refine their process. Whichever method is chosen, they must align with the investor’s ultimate goal.
Final thoughts
Diversifying a portfolio is complicated but well worth the effort. A diverse portfolio means that even when you take a hit, it only affects one part of your overall wealth. Utilize technology and knowledge in equal measure for a secure and diverse roster of investments.
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