MANAGE MARKET MAYHEM THROUGH DIVERSIFICATION
Stop whatever you are doing now and read this article. All investors know market volatility is something they cannot easily digest. How should traders contend with market turmoil?
Here’s a briefer on diversification. Diversification refers to a risk management technique which combines different investments within a portfolio in order to generate higher returns and minimize risk. The rationale behind this technique is the positive performance of some investments will counter the negative performance of others.
There’s more to diversification than simply holding assets. It is all about ensuring all the securities in a portfolio are not perfectly correlated. Diversification is similar to maintaining a balanced diet. In other words, one instrument cannot give you all the profits you need.
Diversification has four characteristics:
- Location – Every investor has a home country bias, even the seasoned ones. We are living in a global economy, so it pays to expand your geographic location to unlock better opportunities in other areas or countries. It is advisable to have a risk-balanced blend of investments across developed and developing markets. Do not forget to account the US dollar’s value against other currencies.
- Quality – You may want to consider diversifying throughout credit quality, including Treasuries. Such derivatives hold a distinct risk/return profile. In case of stocks, look at a company’s balance sheets to determine its dividend growth, earnings, and other related factors.
- Sectors and Styles – Industries react differently to each phase of the business cycle. For instance, discretionary consumer goods and technology gain from economic improvement. On the other hand, food staples and utilities benefit even in times of economic turmoil. Some other styles of stocks should be considered as well, such as value or momentum. Smart beta techniques may also be applied in order to apply such styles.
- Size – In some instances, smaller firms can render bigger returns yet higher risks. On that note, you can come up with a combination of small, medium, and large companies.
Depending on your financial goals, you can reallocate or realign your holdings from time to time. But make sure the portfolio is still diversified.