Diversification: Why It Matters & How to Do It

A little bit of everything goes a long way

It’s that time of the week again! We know this stuff can be a lot to take in (check out the blog if you need a recap), but hopefully you’re at a stage now where you’re starting to make some decisions about where to put your money.

This time we’re going to focus on the latter half of our mantra: start early and diversify. Diversifying your approach to investing is important because not only do you receive income from different sources, it also makes you less reliant on any one product for success.

Saving vs. Investing

Cash is great and necessary, but as we discussed previously, any savings you don’t need access to in the near future can be put to better use in an investment that will grow over time.

Stock markets have gained about 6% on average over the past couple of decades, so an investment made in 2000 would have doubled by now. Property prices in Hong Kong meanwhile, have tripled since then. Cash in the bank doesn’t do that!

Diversifying out of cash is therefore the first (and most important) step for many of us. Cash actually becomes less valuable over time, because of a pesky thing called inflation. Buying a Macbook today is more expensive than it was two years ago, but if your savings are growing too, you can afford to keep up as prices increase over time.

Diversifying Your Investments

Ok, so you’ve started putting some $$ in the stock market…

Maybe you bought a bunch of Tesla or Reliance shares, and are sitting on a nice green +XX% in your account. Do you stick to the winning formula? Or maybe you’re in Hong Kong and bought HSBC like your uncle told you to… that didn’t work out so great, so maybe you just sit out the market for a bit?

You probably guessed this, but the answer to both of the above should be “no”.

Diversifying both within and across asset classes is important, because lots of exposure to just one asset class or one company/ industry jacks up your risk levels and leaves you vulnerable to downturns when unexpected events occur. So not only do you want a mix of different stocks, you also want some bonds, property and gold.

Also, if you’re prone to buying stocks but end up not checking your account for a while or falling out of touch with the news, diversification is a good way to reduce risk. How do you diversify? Keep reading!

Stocks vs. Bonds

Remember, bonds are loans that the company has promised to pay back to you, while stocks are a tiny piece of a company that you own.

Stocks and bonds usually do well at different times in the economic cycle, generally speaking. Stock prices rise when economies and companies are growing (investors are happy to take on some risk), while bond prices rise when economies are stagnating and governments start lowering interest rates to provide stimulus (investors look for safety).

As a 20-something you’re advised to hold more stocks than bonds in your portfolio, as stocks give you a chance to participate in global economic growth over the course of your lifetime. It’s worth re-balancing this allocation, however, as you get closer to retirement. Stock prices can be very volatile in the short-term and that’s not always ideal later in life.

Stock Diversity

Tech is on a dream run right now, but valuations are also sky-high i.e. these stocks are really expensive. What if tech firms go bust the way they did in 2000? Now, we’re not saying that will happen again, and maybe Amazon and Jeff Bezos will be kings of the universe one day… but you always want to protect yourself.

Buying stocks across different industries and different countries is one way to do this. Another way is to diversify across different styles of stocks, with a mix of growth stocks, cyclicals and dividend-paying stocks. You might pick a couple of companies in each category, or you might choose to buy index-tracker ETFs to dilute your risk even further (or all of the above!).

Regardless of how you choose to diversify, remember that you’re buffering some of your downside next time there’s an unprecedented event like Covid-19 that puts entire industries under pressure.

Bond Diversity

We’ve touched on this a little before, but companies’ bonds are generally categorized as either high-yield (riskier, higher interest rates) or investment-grade (safer, lower interest rates).

To diversify your bond holdings, you might look into buying some bonds, or bond ETFs, that fall into each of these categories. Your high-yield bonds will provide income while the investment-grade bonds will act as a solid base.

Also, much like with stocks, going global with bonds across different industries limits your exposure to any one company or country.

Bond yields in the developed world are currently at rock-bottom levels i.e. bond prices are high. Adding some developing market bonds will add higher yields to your portfolio and also serve as a hedge if interest rates start to rise in the U.S. and Europe (which will cause bond prices there to fall).

What About Property? Gold?

Good question, and this is something we haven’t talked about a whole lot. Stocks and bonds aren’t the only way to invest your money… if you live in a place where property prices have risen over time, real estate should definitely be part of your portfolio.

Can’t afford to buy a house just yet? You can look into Real Estate Investment Trusts (REITs), which are like ETFs but comprised of property holdings instead of stocks/ bonds. You won’t actually get a house when you buy one of these but they’re an easy way to participate in rising real estate prices and diversify out of stocks.

Gold is also an important asset that sometimes gets overlooked. We live in a crazy world where a lot of the old rules don’t apply anymore, but gold can still be a good hedge if markets are tanking as it’s generally viewed as a “safe haven”. We’re not talking physical gold (although if that’s your jam, why not?), but there are tons of ETFs that track gold prices e.g. GLD is a popular one. The same goes for other commodities such as oil and copper.

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TL;DR? Don’t put all your eggs in one basket! Concentrated bets are fun while they last but can also turn sour very quickly.

Thinking from a long-term perspective, the more companies and different asset classes you’re exposed to, the less reliant you are on any one of them to prop you up - plus you get to share in the growth of a wide variety of products and industries.

Note, these posts are intended as an educational resource and to encourage participation in the stock market. None of our opinions should be taken as investment advice, please speak to a professional for that :)