How to Diversify Your Investment Portfolio
A simple guide

 

By Stephan Joubert

 

Imagine this, you have been hearing countless success stories of the tech giants and after some in depth research decide to pour all your savings into buying shares in a single promising tech start-up. The company’s innovative product and charismatic CEO has you convinced that this is a one-way ticket to wealth. For a while, the gamble pays off; the share price soars, and your investment is multiplying! But then, unexpected regulatory issues surface, and overnight, the share price plummets. You watch in disbelief as your portfolio’s value dwindles to a fraction of its peak, your nerves and the odds of recovering from this loss, hanging on a thread…

This nightmarish scenario underscores the importance of diversification of your investment portfolio. By spreading investments across various asset classes, sectors, and geographies, investors can mitigate the risks of catastrophic losses and navigate the unpredictable tides of the financial markets with greater confidence. Let us explore some of the fundamentals of diversifying your portfolio:

 

1. Understand Asset Classes

A traditional investment portfolio can consist of various asset classes. These asset classes are:

Equities (shares): This represents ownership in companies by purchasing shares. Equities usually provide the highest returns over the long term, but also have the biggest risk associated to it, especially in the short term.

Property: This includes listed property, property trust funds, direct property investment, and property syndicates. The success of this asset class is often not dependent on the performance of the markets.

Bonds: Debt securities issued by governments or corporations. These types of bonds are usually lower-risk investments, and the value of the investment is often impacted by changes in interest rates.

Cash (or cash equivalents): This asset includes fixed deposit accounts, savings accounts and money market funds. Cash is a low-risk, highly liquid asset.

 

2. Diversify by Asset Class

The idea of investing in different asset classes is to avoid overexposure to any single asset type. An example: If the equity market drops, bonds may provide stability. When compiling your investment portfolio, it is important to factor in aspects such as your risk appetite (this is your willingness as an investor to take on financial risks to generate a potential gain) as well as your investment time horizon. Typically, one may find that the longer you remain invested in the markets the better the returns look. This is because you are allowing compounding returns to work in your favour.

 

3. Diversify Within Asset Classes

As an investor you should diversify your portfolio, not only across various asset classes, but also across different types of assets within the same category. For example, when buying shares, consider different sectors (technology, healthcare, financial services) as well as geographies (S.A., U.S., Europe etc.). Consider the effects of the current and future political climate as well as the effects of the exchange rate for example. When investing in unit trusts or exchange-traded funds (ETFs) you usually enjoy the benefit of a broader diversification.

 

4. Stick to your investment philosophy

Avoid switching your underlying funds too frequently; it increases costs and risks. Clearly define your short-, medium- and long-term investment objectives. Carefully choose your relevant investment strategy on how to best obtain the desired results and trust the process.  In 2022 Momentum Investments published a report indicating that the investors on their platform managed to destroy about R 100 million of their wealth by switching in and out of the market at the wrong time. This was primarily driven by fear and uncertainty caused by the COVID-19 crisis.

 

5. Rebalance Your Portfolio

Even though future market performance can’t be predicted, one thing is certain - markets change, and it is a good idea to assess your portfolio periodically. An annual review of your investment portfolio can help in determining whether you are still on track to reach your investment goal. Selling off some asset classes to buy into a different asset class may be necessary as you are reaching the closing stretch of your investment period. Once again, it is important that you understand the underlying asset classes and the kind of risks associated with them.

Remember, diversification won’t eliminate all risk, but most investment professionals agree that diversification is the most important component of reaching long-term financial goals while minimizing risk.

For an interesting take on diversifying your investment portfolio have a look at our video: