Investments have become the order of the day as many Nigerians are searching for more ways to financial freedom. The downside to the various investment options available are the associated risks, although many do place investors on the journey to making more. In the midst of all this diversification is helping to reduce the effects of risks on investment portfolios. In this article, we examine what diversification is and why you need it and how it can be achieved.
What is Diversification?
Diversification is basically a spread of investments across different assets. It is designed to reduce the exposure of funds to risk and the volatility of your investments to the various market conditions.. According to Investopedia, diversification is a risk management strategy that mixes a wide variety of investments within a portfolio. A diversified portfolio contains a mix of distinct asset types and investment vehicles in an attempt at limiting exposure to any single asset or risk. The rationale behind this technique is that a portfolio constructed of different kinds of assets will, on average, yield higher long-term returns and lower the risk of any individual holding or security.
Diversification is a technique that reduces risk by allocating investments across various financial instruments, industries, and other categories. It aims to maximize returns by investing in different areas that would each react differently to the same event.
How to Achieve A Diversified Portfolio
An investor can achieve a diversified portfolio by using essential components of a diversified portfolio. Here are 4 primary components of a diversified portfolio:
Stocks are generally one of the most common forms of investments, they are more volatile than many other investment forms however they are profitable when terms are favourable.
Domestic stocks are stocks that are of companies that operate within a country. They make for an aggressive portion of many investment portfolios. Stocks are affected by changes in the economy of that nation of which the investor may be able to predict or get wind of early enough to avoid losses, these stocks are considered by many to be low risk. International stocks, on the other hand, are stocks issued by countries outside the investor’s country and are controlled by an economy outside of the investor’s country. Considering these stocks are affected by different economic conditions, the contrast makes them an excellent addition to a diversified investment portfolio.
Bonds are commonly known for being a stable form of income. They provide regular income Most bonds provide regular interest income and are generally considered to be less volatile than stocks. They provide a cushioning effect to the volatility of stocks on the investment portfolio. The downside of bonds is that they do not offer as much returns as stocks do. They are a great choice for investors who can’t handle risks, don’t mind the slow growth rate and will choose safety over growth. However, note that some fixed income investments, like high-yield bonds and certain international bonds, can offer much higher yields, albeit with more risk.
Short term investments just as the name implies are investments, across any industry that allows investors get their returns in only a short period of time. These include money market funds and short-term CDs (certificates of deposit). Short term investments tend to offer investors high returns, but they are generally high risk.
Long term investments
Long term investments are investments that keep the return on investment of investors until a later time i.e longer than short term investments. Long term investments are very stable investments, they however do not always offer returns as huge as returns of short term investments.
Why Diversification is Important
- With diversification, you are able to balance your investments with your time. what this means is that you are able to invest as the time of your life allows. More younger individuals than older ones invest with more risks as they are looking for higher and quick paying returns. Older individuals who are close to retirement don’t have the time to try out missing money and their risk appetites will definitely be lower. When you diversify, you can do a little bit of both without dire consequences.
- Diversification helps offsets the effects of the risks of volatility, inflation and risks associated with investments.
- Diversification allows investors to enjoy the benefits of different investment schemes.
- Diversification protects capital and minimizes the risk of loss.
In all, diversification is important to maintain safety of funds and minimize losses while ensuring that both your capital and return on investments are kept stable and secure. Taking that chance on diversification is taking a chance on a journey to a stable investment portfolio.