LENSELL EDUSeries: Episode 1 - Diversification 101!
'IS INVESTING A SCIENCE OR ART?' - For many years, investors have debated this question.
We believe it is both - a balance of science and art. Investing is psychological (involving emotions, attitudes, habits and expectations), and at the same time, it is based on data, years of research and evidence. At LENSELL, we aim at the 'science' part by making financial literacy accessible to everyone so that you can make informed investment decisions and grow financially. Thus, we have launched our financial, educational series, 'LENSELL EDUSeries', where you can get monthly updates about everything finance. This month's topic is – Diversification 101!
According to the ASX report (2020), "only 3 in 10 investors' portfolios are diversified."
What Is Portfolio Diversification?
Portfolio Diversification is a concept introduced by Harry Markowitz in 1952 in the Modern Portfolio Theory, developed to mitigate portfolio risk and the risk of ruin. As a risk management strategy, Diversification means mixing a wide variety of investments in a portfolio. Diversification reduces the risk by allocating investments to channels that span diverse financial instruments and industries that would each react differently to the same market events (Investopedia, 2021).
In short, Diversification means dividing your funds across different assets to avoid the scenario of having all your eggs in one basket.
Why Do You Need Diversification?
The direct answer is: to minimize your investment risks. In the era of COVID-19, unpredictability and instability are the new norms of life. Since the future is uncertain and markets are constantly changing, it is now more than ever crucial to diversify your investments among different companies and assets that are not exposed to the same risks (Forbes, 2021).
Remember, Diversification is a long-term game. At times, investors who concentrate funds in narrow channels of high-growth investments may outperform a diversified investor. However, research shows that diversified portfolios are more resilient to market volatility and generally outperforms 'concentrated' portfolios in the longer run (Koda Capital, 2020).
Everyone talks about the importance of a diversified portfolio, but they rarely highlight the challenges:
- Diversification can be expensive - diversifying your portfolio comes with additional charges (from transaction fees and brokerage fees), and since higher risk comes with higher rewards, you may end up limiting your returns (Investopedia, 2021).
- Managing a diversified portfolio can be challenging - if you have multiple investments, then reviewing and refining your portfolio to keep up with diversification can be time-consuming.
- Diversification is not a guarantee - diversification is a complicated process that provides a safety net against various stock market risks. While it does not guarantee that you will not be losing any money, diversification can reduce the negative impact of some market events on a carefully selected portfolio.
How can You Diversify Your Portfolio?
The key to diversification is owning investments that perform differently during the same market cycles and events. There are various diversification strategies employed by investors, with one thing in common – buying investments in a variety of asset classes and in different industries. At LENSELL, we call this high-level diversification, and we show that it is less effective than granular diversification (stay tuned for another, more detailed article on this topic).
Check out these articles for more information:
- Diversified Investments with Examples: Six Assets You Should Own Now (Thebalance.com, 2021).
- The Upside of Maintaining Diversification (Michael Massey, 2020).
- Why Diversification matter (Fidelity.com, 2020).
- 5 Tips for Diversifying your Portfolio (Investopedia.com, 2020).
- 4-Step Guide for how to Diversify your Portfolio (Moneyunder20.com, 2020).
At LENSELL, we have decided to help investors achieve excellence in diversification! Hence, we have launched a new and improved Diversiview® V3.0 - The #1 Portfolio Planner. Affordable, cloud-based and very easy to use, Diversiview® helps users design tailored, risk-informed portfolios of ASX listed investments so that they can plan their investment journey with ease and confidence.
One way Diversiview® helps in achieving excellence diversification is by offering access to a Granular Diversification Diagram. The diagram shows the correlations between pairs of individual securities, enabling investors to identify areas of potential concern and make appropriate decisions. Other useful insights are available; make sure you check Diversiview® for free.
That's all for this time. Learn more about Diversiview®, and don't forget to subscribe to our newsletter for your monthly dose of finance!
- Team LENSELL