The Key to Diversification
I put money in a mutual fund a year ago. It was my very first investment. Now I’m looking to diversify my portfolio. What instrument would you recommend I tap next? And how do I make sure I diversify enough?
[JJT]: First off, you have to understand that the reason we diversify is that we want to lower our risk. Diversifying would help you offset any loss in one investment instrument by gains in another. Since it lowers the risk, it can also lower your potential returns. Before we talk about the different investment instruments, let’s first talk about a couple of ways you can diversify your portfolio.
Diversifying by asset classes. Since your first investment is through a mutual fund, you’ve already selected an asset class to invest in. Asset classes include cash, bonds/fixed income securities, equities or stocks, properties/real estate and money market instruments. Chances are, your mutual fund is invested in one of these (except properties). So depending on the type of mutual fund you got, you can pick another asset class that is not the same as the one in which your mutual fund is invested. Each asset class also has its own pros and cons, so you’d have to consider different factors such as liquidity, risk tolerance, time horizon and investment strategy.
Diversifying by industry. Another form of diversification is according to industry. A perfect example of someone who has diversified in such a way is the country’s richest man, Henry Sy. He has invested in financial services through banks, real estate, logistics and retail, just to name a few. If you have the fund and the willingness to take risk, then getting into different businesses can be an option. But in case you are not willing to take that much risk, you can still diversify by industry by investing directly in stocks and picking different companies from varied industries.
So how do you now pick an investment instrument? Here’s where your goal and preference would come in. In case you want to be investing for the long term, you can choose to get into real estate or long-term bonds. If you like a little liquidity, you can select a mutual fund of different asset classes, stocks, or you may consider maintaining a time deposit in a rural bank where risk is a little higher but interest rates are better. If you want to address short-term goals, you can go with money market instruments, T-bills or notes. If you are more adventurous you can start your own business or you can do stock trading instead of long-term stock investing.
To be honest, there is really no right or wrong answer here. There are a lot of factors you can consider that are personal and only you can answer. At the end of the day, though, what’s important is that you know what you are getting into and you understand how the chosen investment works. Doing your due diligence already lowers your risk. As the famed investor, Warren Buffett, once said, “Risk comes from not knowing what you are doing.” And the only time you’ll know you’ve diversified enough is when you feel very comfortable that what you have is enough to be able to help you reach your goals.
Jeremy Jessley Tan, RFP®, is a registered financial planner of RFP Philippines. To learn more about personal financial planning, attend the 65th RFP program this October. To inquire, email firstname.lastname@example.org or text <name><e-mail><RFP> at 0917-9689774.
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