Tag: diversified investment

  • Diversification Is Important to Your Investment Portfolio

    Diversification Is Important to Your Investment Portfolio

    Diversification Is Important to Your Investment Portfolio
    When stock prices drop, bond prices increase. A portfolio that holds stocks and bonds plays better than the one that holds only stocks.

    Diversification means to spread the risk across different types of investments. The main purpose of diversification is to enhance your chances of investment success. In other words, you are betting on every one.

    Diversification is very important in investing because markets can be volatile and extremely unpredictable. If you diversify your portfolio, you will reduce the chance to lose more than you are prepared to.

    And that is exactly what you would like in investing: to spread your capital among different assets. So you’re not relying on a single asset for all of your returns. The key advantage of diversification is that it provides you to minimize the risk of losing the capital invested.

    What is diversification?

    Diversification means building a portfolio of your investments in a way that the majority of the assets will have a different reaction to the same market performance. For example, when the economy is growing, stocks will outperform bonds. In opposite circumstances, bonds could play better than stocks. Hence, if you hold both stocks and bonds, you will reduce the risks in your portfolio from market swings. 

    Let’s make this more clear. What do you have in your pantry? Only beans? Of course not! When you went to the grocery you bought everything you need for the week or month ahead. The same should be with your investment portfolio. It should consist of various assets. But not too many. Too many assets mean you will not be able to follow their performances. If you are fresh in the stock market, maybe a two-fund portfolio is a good choice for you. More about this you can read HERE. 

    Think of these various types of groceries as the different areas, techniques, and areas available to you as an investor. If you have a variety of assets, you’ll be better protected. In the situation when one of your assets is hit by the risk you will still have the others that can give you a profit.

    Reasons for diversification

    Even the explanation is so simple you can still find so many investors that play on one card. You may ask how some really smart guys could avoid diversification and put all eggs in one basket? We couldn’t find the proper answer because the benefits are so obvious.

    By diversification, investors lower the overall risk. It is logical how this works. When you spread your investments in various classes (diversifying them) you have more chances to avoid the negative influence in your portfolio. For example, let’s say you invested in stocks only and you hold a stock of just one company. Yes, we know you like it, it is a good company, famous, well-run. But if suddenly something unpleasant hit it and the stock price drops, let’s say, for 30%, how that occasion will influence your overall portfolio? You will lose 30% of your portfolio.  But let’s consider the other situation. Let’s say that stock makes up a modest part of 5% in your portfolio. So, how much of your overall portfolio you will lose now? Can you see where is the benefit of diversification? It lowers the risk. Even during economic downturns, you will still have good players in your portfolio. Hence, if you have bonds and stocks added to your portfolio, it is more likely that even one of them will run well during particular circumstances. Bonds will play better when the economy is decreasing, but when the economy is growing, stocks will outperform bonds.

    Diversification and investment strategy

    You can find various investment strategies but two are most popular: growth and value investing.

    Value investors tend to consider the strength of a company and its management. They would estimate if the company’s stock price is undervalued based on its true worth. 

    On the other side, growth investors would estimate how fast the company is growing, could its new products stimulate future earnings, etc.
    By taking just one strategy you can miss out on the benefits of the other. But if you spread your investments on both of these strategies, it is pretty sure that you’ll be able to enjoy the benefits of each.

    Influence of “home country bias”

    Well, it is completely natural that investors are more attracted to their own state markets, the national industry. That’s how we come to the “home country bias”  in investing. Of course, it is a natural tendency. But it can be a problem too. “Home country bias” can limit your investments to the offer from domestic markets. But what is needed for profitable and successful investing is to step out of your comfort zone. Foreign markets can be profitable also. What you have to do as an investor is to add some international fund or company to your portfolio. It is good protection and well-done diversification. Diversification across international markets will protect your investments if the domestic economy downturns (no one wants that, of course) or during the recession in your country. Several years ago we heard one of the investors saying it isn’t a patriotic gesture. Well, we have to say, investing isn’t an act of patriotism. It is all about profit.

    Produces more opportunities

    Eventually, diversification produces more opportunities if you make smart choices that deliver balance to your investment portfolio. 

    For example, you only invest in stocks. But suddenly some great opportunity occurs to invest in, for example, bonds. What will you do? Refuse to invest in bonds because you are not comfortable with them and risk to miss potential profit? We don’t think it is a smart idea. Never miss the opportunity to earn more, that isn’t in the nature of investing. Admit, you will never miss this opportunity to invest in bonds if you have a diversified portfolio. So, diversification gives you more opportunities to invest.

    Protect and improve your finances

    It is important to understand all the benefits of diversification. It isn’t hard to do. Actually, it is very simple. You have to read more, learn and be patient. If you diversify your investment portfolio you will have a chance to build stable finances over time.

    How to diversify your portfolio

    Firstly, never be too much invested. You will not be the winner if you own hundreds of assets. Okay, let’s say this way. Your portfolio is your team. And, as in every team, each part plays its role. No coach will put all players in one position. It’s stupid. Plus, how such a team will win anything? Of course, zero chances! 

    The point of diversifying is to hold investments that able to work separated tasks on your team. 

    Every single part of your portfolio should have a different role. For example, if you prefer stocks, diversify your portfolio to S&P 500 (that would provide you exposure to large-caps) and add some small-caps.

    If you have a bond portfolio diversify it across short and long bonds, or higher-quality bonds, etc. That will reduce the risks. Or just add alternative investments in your portfolio. For example, private equity, hedge funds, real property, venture capital, commodities, etc.

    Bottom line

    How will you know you’re diversified? A well-diversified investment portfolio will never move in the same trend and at the same time. You must have one thing on your mind: you are the manager of your portfolio. Also, it is almost impossible for all investments to grow all the time. It is 100% sure that some of your positions will be lost, will lose you money. When that happens you will need the other holdings to balance that fall.

    Diversification guards you against producing an undesired risk to your capital. Anyway, it is too risky to put all your money into one single investment. The key to diversification is to spread your money across asset classes and to allocate within classes. That is a smart approach.

  • Alternative Investments Role in Diversified Investment

    Alternative Investments Role in Diversified Investment

    What is The Role of Alternative Investments in Diversified Investment
    Investors should pay attention to several issues when adding alternatives to their investment strategy.

    By Guy Avtalyon

    Alternative investments, which have been used by large institutions and foundations for quite some time, have become more mainstream in the last years. They are more popular among individual investors. Also, there are more available products, which makes investing in alternatives possible for an increasing number of investors.

    Alternative investments are a non-traditional approach to investing. They give the ability to invest in sectors and access to assets that traditional investments cannot provide. Investors should understand alternative investments as the potential to improve the overall risk-return ratio of your portfolio. Even a small allocation to alternatives may be reasonable and profitable now for more investors. Previously it wasn’t the case.

    However, the non-traditional approach and structure of these investments bring with them unique risks of which investors must be aware of.

    Alternative investments have a different approach

    Alternative investments use a different approach to investing than do traditional equity or fixed-income investments.
    This approach may require holding both long and short positions in securities. Also, it may require to hold private securities instead of publicly-traded investments. And there may be derivatives or hedging strategies as well. Also, investors that use alternatives have a goal to achieve a distinct level of total return. The other investors’ goal is the opposite, they usually pay more attention to relative performance versus an index.
    Alternative investments have the potential to magnify the risk but also returns of an investment portfolio. They can possibly improve diversification and reduce risk. This approach is more flexible, investors have a chance to invest in a more extensive set of investments, so the possibility of enhancing returns is obvious.

    Different risk

    Alternative investments have risks different from traditional investments. They are less liquid, especially in periods of high pressure in the markets. Also, they are more complex and less transparent. These characteristics make it difficult for inexperienced investors to understand and they are more subject to investment manager failure.

    The successful implementation of an alternative investment strategy relies largely on the investment manager’s experience and skill because of the wide range of investment opportunities.

    Satellite asset classes as Alternative Investments

    Satelite asset classes are very suitable for portfolio diversification. They cover everything that traditional investors and funds managers don’t even think about. They are more interested and specialized in asset classes such as real estate, commodities, any that can give high-yield fixed income. Satellites are non-traditional and have a low correlation with traditional assets. But their performances are driven by exposure which represents the similarity with traditional investments.

    Types of Alternative Investments

    We highlight several types of alternative investments but this list is more illustrative than exhaustive because new approaches are constantly being developed.

    Private equity

    Private equity is an investment strategy. Its goal is to take part in the growth of the private company. Hence, this strategy is long-term investments all in private securities generally and globally.
    Private equity investment strategy covers illiquid asset classes with potentially greater long-term capital appreciation. The diversification doesn’t include public markets.
    Only to higher-net-worth individuals use this strategy because it requires more investment experience, hence they are often accredited investor at high minimums and often has liquidity restrictions.

    Hedge funds

    The hedge funds are an alternative investment. They are designed to protect investment portfolios from market changes, so they will generate positive returns no matter if the markets are up or down.
    They could protect the investment from market risk by adding alternative investments to the portfolios to decrease loss and protect capital.
    The term “absolute return” is broadly used in connection with hedge funds. This explains how investment strategies are created to generate returns in any market condition. Actually, these funds are “hedging” the markets.

    Managed Futures

    An investment strategy that seeks to participate in trends in a large variety of global futures markets. Strategies include the use of the stock index, interest rate, currency, energy, and commodity futures. Many managed futures traders apply sophisticated software designed to invest in a disciplined, unemotional fashion, which often results in a lower correlation with traditional assets.

    Alternative investments – mutual funds

    These funds are not forced by traditional portfolio management systems. They have varying approaches, ranging from the absolute return, long/short equity, a broad mandate, or “go-anywhere” funds, and hedge fund-like strategies. Many of these funds also have a total return or an absolute return objective. They provide access to non-traditional investment. But they also provide investors daily liquidity at fair investment minimum.
    Alternative investments can be useful tools to improve the risk-return of an investment portfolio. They can increase diversification and reduce volatility, given low correlations to more traditional investments.

    Risks of Alternative Investments

    • Higher fees.  – Alternative investments can have higher fees. They may also charge additional management fees. While higher than traditional investments, these fees may or may not be excused when comparing returns net of fees.
    • More complicated.  – Alternative managers invest in a broad variety of investments, such as derivatives, and can use short selling. Understanding that can be difficult for many investors.
    • Less transparent.  – There can be limited to the underlying holdings of these investments. They use many tools that are not always the best choice for alternative investments. That makes a manager’s investment ability more difficult to assess. Also, some alternative investments are largely unregulated.
    • Less liquid. – This is due to holding illiquid investments that can restrict the investor’s ability to offset money invested. For example, some hedge funds do not allow redemptions over the first year of investing. Most of them will allow annual or quarterly redemptions. Moreover, private equity may not allow redemptions for more than seven years. Here is also exposure to a notable lack of liquidity in some trading environments.
    • Less tax-friendly. – Most alternative investment strategies aren’t focused on minimizing taxes.
    • May disappoint in strong up markets. – They use short sellings to generate absolute returns. That may deter some investors.
    • May not diversify risk in extreme down markets. – During the dislocation, the relationships of many different types of investments may increase notably. Investors hold that the more profits of alternatives is connected to the added risk.

    Is this suitable for every investor?

    Alternative investments can potentially magnify the overall risk-return of an investment portfolio. There are benefits but also risks in these non-traditional investment strategies. The most important is that investors have to be comfortable with alternatives when adding them to their investment strategy.
    It is important also to discuss alternative investments with a respectable financial advisor. If you choose this strategy you’ll first need to determine how suitable it is in relation to your current investment approach.

  • What is Diversified Investment

    What is Diversified Investment

    2 min read

    What is Diversified Investment

    Nothing more represents the term diversified investment than proverb “Don’t put all your eggs in one basket.” Instead, invest in many baskets and hold a substantially diversified portfolio based on your long-term asset allocation strategy.

    A diversified investment is exactly that.

    A diversified investment represents a portfolio of various assets that earn the highest return for the smallest risk. This kind of portfolio has a mixture of stocks, fixed income, and commodities. These assets react differently to the same economic occasions and because of that, diversification works. With diversified funds, you can access financial markets while spreading your investments across several asset classes and geographic regions. In this way, you reduce the impact of market fluctuations while maintaining an attractive potential performance.

    In a diversified portfolio, the assets don’t match each other. When one rises, the other falls. It drops down overall risk because some asset classes will benefit, no matter what the economy does. They equalize any losses of the other assets. There is also less risk because it’s difficult the entire portfolio would be destroyed by any single event. A diversified portfolio is the best protection against a financial crisis.

    How does Diversification work?

    Stocks do well when the economy grows. Investors want the highest returns, so they bid up to the price of stocks. They are willing to accept a greater risk because they are optimistic about the future.

    Bonds do well when the economy slows.

    Investors are more interested in protecting their holdings. They are willing to accept lower returns for that reduction of risk.

    What is Diversified Investment 1
    The prices of commodities vary with supply and demand. Commodities include wheat, oil, and gold. For example, wheat prices would rise if there is a drought that limits supply. Oil prices would fall if there is additional supply. As a result, commodities don’t follow the phases of the business cycle as closely as stocks and bonds.

    Diversification typically has low correlations to, or do not move in lockstep with, more traditional asset classes. As such, their inclusion in an investment portfolio tends to result in lower overall volatility.  Because they have a wider universe in which to invest (public and private) and do not have some of the same investment constraints (can short and hedge), alternative investments have the potential for higher long-term performance than traditional investments.

    Investing in diversified funds can, therefore, be an effective tool to:

    • Seek growth in your savings with a medium-term outlook and moderate risk
    • Benefit from exposure to several markets (equity, bonds) that is adjusted to match current conditions in order to both take advantage of market rallies and cushion against the impact of declines
    • Manage your portfolio simply with access to turnkey management: the manager adjusts the make-up of your portfolio over time.

    Where can you execute the diversified portfolio?

    A diversified portfolio should contain securities from the following six asset classes.

    Stocks. Different sized companies should be included. Company size is measured by its market capitalization. Therefore, include small-cap, mid-cap, and large-cap in any portfolio.

    Fixed income. The safest are savings bonds. These are guaranteed by the government. Municipal bonds are also very safe. You can also buy short-term bond funds and money market funds that invest in these safe securities. Corporate bonds provide a higher return with greater risk. The highest returns and risk come with junk bonds.

    Foreign stocks. These include companies from both developed and emerging markets. You can achieve greater diversification if you invest overseas. International investments can generate a higher return because emerging markets countries are growing faster. But they are riskier investments because these countries have fewer central bank safeguards in place, can be susceptible to political changes, and are less transparent.

    Foreign fixed income. These include both corporate and government issues. They provide protection from a currency decline. They are safer than foreign stocks.

    Commodities. This includes natural resources such as gold, oil, and real estate. Gold should be a part of any diversified investment because it’s the best hedge against a stock market crash. Research shows that gold prices rise dramatically for 15 days after the crash. This is why people invest in gold. Gold can be a good defense against inflation. It is also not correlated to assets such as stocks and bonds.

    Maybe you should include the equity in your home in your diversification strategy.

    If your equity goes up, you can sell other real estate investments in your portfolio. You might also consider to sell your home, take some profits, and move into a smaller house.
    What is Diversified Investment 2
    Most investment advisors don’t count the equity in your home as a real estate investment. They assume you will live there to the end of the time. They saw it as a consumable product, so that encouraged many homeowners to loan against the equity in their homes to buy consumable goods. When housing prices declined, they owed more than the house was worth. Many people walked away from their homes while others declared bankruptcy.

    Expected return

    Investors often focus too much on the expected return of their portfolio. While the expected return is important, you must also consider the amount of risk that you need to assume in order to achieve that expected return – the higher the expected return, the more risk you must take on to achieve it. When planning your investment strategy, it is important to be truthful with yourself in evaluating how much risk you can manage, and how long you are able to stay on the course through the ups and downs of the market rhythm. With other words, you should determine how much short-term volatility you are willing to accept.

    A little bit of history.

    An academic named Harry Markowitz introduced the research on what he called modern portfolio theory that people were able to understand diversification in an objective, mathematical sense. This research was so innovative and Markowitz earned a trip to Sweden to pick up a Nobel Prize.

    The bottom line

    In Shakespeare’s play, “The Merchant of Venice,” written more than 400 years ago, the character Antonio demonstrates his understanding of the concept. He says: “I thank my fortune for it – my ventures are not in one bottom trusted, nor to one place, nor is my whole estate upon the fortune of this present year.” That is a diversified investment.

    Risk Disclosure (read carefully!)