How to Diversify Your Investment Portfolio (And Why You Should Do It)
Thank you to our partners at Black Swan Capital for helping us understand why diversification in investments can help us achieve our financial goals!
Change is the only constant. No industry, no person, no land — nothing is immune to the effects of time. And that includes investments.
But with a diverse portfolio, you can reduce the risk of diminished returns. By distributing your risk over a variety of asset classes, you can increase the chance to achieve your long-term investment goals.
What Is Diversification?
Diversification is essentially the investor’s response to “Don’t put all your eggs in one basket.” David Bellingham from Black Swan Capital defines it as “Spreading your investments across different types of assets or different types of investments to reduce your risk.”
For example, in times of crisis, the hospitality industry can suffer from a decrease in travelers. If you only invest in hotels or airlines, you risk not seeing returns during that time.
If, however, you have a diverse portfolio that includes investments in airlines, fintech, logistics, agriculture, and energy, at least one of those industries should not be as negatively affected as hospitality.
When talking about portfolio diversification, there are three types of relationships assets may have:
- Positive Correlation: The two assets can be affected the same way by the same factor
- Negative Correlation: The two assets may respond in opposite ways to the same factor
- No Correlation: There is no relationship between how the two assets respond to any given factor
For example, the COVID-19 pandemic devastated the hospitality and travel industries. In March 2020, Air France-KLM cut 90 percent of its flights and permanently eliminated 2,000 jobs. But in contrast, new technologies that support virtual office teams and classrooms remain stable. These industries are not negatively correlated, but they did respond differently to the same factor.
Of course, there is no guarantee that any of your investments will be completely immune to volatility. Diversification also does not guarantee profits, and there is a chance you will experience short term losses. But variation in your investments can lower your portfolio’s susceptibility to risk over time.
How Do I Diversify My Investment Portfolio?
Diversifying and investing should be about achieving your financial goals for a comfortable future. Some investments may be better in the short term, while other assets may offer better returns in the long run. A balanced variety of assets can earn a steady profit over time, despite changes in the economy.
Diversification of assets may include a mix of property, stocks, bonds, cash, or commodities. But diversification doesn’t just apply to assets – you can also diversify geographic location and currency. Investing in different markets may be especially interesting for you as an expat.
For example, you can invest in auto manufacturers in India and in English real estate. The investments are in different sectors, on different continents, and in different currencies. As a result, if one of those markets experiences a downturn, the other one should not be as negatively affected.
And keep in mind that all markets will fluctuate over time. To ensure that your investments consistently work for you, remember to evaluate and balance your portfolio on a regular basis.
Consider what happens during a global recession. Stocks may fall farther than bonds or cash because they do not guarantee returns. Bonds, on the other hand, have guaranteed returns, and cash may be insured by a government. As a result, an investment portfolio can become more conservative than originally anticipated.
And while conservative investments may be favorable in the short term, it may be difficult to achieve long term goals. So be sure to check your investment portfolio to ensure its diversification is still on track to meet your needs.
Looking Diversify Your Investments?
The future is always unpredictable, but a diversified investment portfolio can help you stay prepared and reach your financial goals. By distributing the risk over a variety of assets and markets, you can increase your potential for growth whilst minimizing risk.
Creating and maintaining an investment portfolio in times of uncertainty can be difficult. To learn more about building an investment portfolio that works for you as an expat in the Netherlands, contact Black Swan Capital today!