In the Middle of Life is a Big “IF”
The big “IF” or question mark in investing called risk, while always present, can also be managed through diversification
In the many years that I have been a fund manager and investment adviser, I had always come across risk-averse people who would prefer investments that had a fixed interest rate, a short-term tenor and a guarantee. Typically, only bank time deposits, treasury bills and similar instruments would fall under such criteria.
Unfortunately, interest rates in the Philippines and elsewhere are at unprecedented low levels. To get better returns that can beat inflation and provide for major future life events, investors would need to turn to instruments with only a potential to provide higher income, a long-term nature and without any guarantee on income and the return of principal. Is the investor left with no choice then but to reluctantly take on higher risk?
Just like in life where the future is a big “IF” or question mark, all investments bear risk, even in those preferred by risk averse people. Risk, and more particularly the fear of it, is not an abnormality any more than the act of sneezing is when an allergen is in the air. This fear is there to teach us to be careful in the face of risk.
When it comes to investing, the best strategy to take in the midst of risk is none other than to manage it by following the old adage of not putting all of your eggs in one basket. In investing, this is called diversification.
In recent years financial crises have, in different ways, affected investments around the globe. The 2008 global financial crisis is one clear example. As Fareed Zakaria put it in his book, “The Post American World”, the recent financial crisis was not exactly global in nature but was more a crisis of the West. The US and Europe were hit hard by the crisis. The rest of the world however was not as badly hit. Asia, Africa,
Latin America and the Middle East continued with their economic progress albeit at a decelerated pace.
That is why the best way to diversify is to find investments in different industries, asset classes and geographies that can behave almost inversely proportional to each other. In periods of recessions for example, shares of stocks of companies with declining revenues will deflate in price. In periods of recession, interest rates typically also decline, which then gives way to rising bond prices. So it pays to spread money between stocks and bonds.
But, and there is always a “but”, over diversification is also not good. A 20% gain on an investment that comprises only 3% of a total investment portfolio, which has so many instruments in it, will still move that portfolio up by only 0.6% (all other things being equal).
So remember that the big “IF” or question mark in investing called risk, while always present, can also be managed through diversification. Just don’t overdo it.
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For now, stay safe in investing.
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