For my first official post on DINKS Finance I have decided to stay within my comfort zone of personal financial advice. I know that generally all financial planners give similar advice, but this is where I break the black and grey suit mold. Of course you can read about the benefits of portfolio diversification, and of course it is important to understand why you should diversify your investments. However, it is more important that you understand exactly what portfolio diversification is.
Some people say that the number one rule of investing is “Don’t put all of your eggs into one basket.” Some other people say that “You can never have too much of a good thing.” Both of these rules are good pieces of investment advice, especially when they are combined together. This is a strategy that is better known as investment portfolio diversification. Investors should not have all of their money invested in exactly the same place but they should have just enough money in one place to fully benefit from the investment option.
Diversification is an investment strategy that encourages people to invest their money in a variety of different ways. Diversification can be among investment instruments such as bonds, segregated funds, stocks, and mutual funds. This strategy gives the investor exposure to different levels of risk that range from low risk with secure investments such as bonds to higher risk investments such as stocks and mutual funds.
A benefit of having several investments with different levels of risk in the same portfolio is that they will have different rates of return depending on the current market conditions. As the market fluctuates each investment will respond accordingly. This is beneficial to investors because markets are unpredictable and more recently unstable.
For example when interest rates fall, the rate of return on more secure (interest bearing) investments such as money market and bonds will increase. The opposite is true for higher risk equity investments such as stocks and mutual funds. As the market increases the rate of return on equity investments should also increase. Therefore through diversification you can minimize your potential losses. This is why you should always try to have a balanced investment approach.
Diversification can also refer to the currency in which you invest, as well as the country, or the sector such as technology, pharmaceuticals, or precious metals.
It is a common misunderstanding that to diversify means to diversity amongst different financial institutions or with various investment brokers. The rule of diversification refers to how your money is invested, and not with whom it is invested.
Please keep in mind that these are general guidelines. Investors should always choose their personal investment strategy with the assistance of a professional. Having a variety of investment options and choices available is definitely more helpful to investors than it is hurtful.