Diversification as protection

Setting up an investment portfolio for the more cautious amongst us often becomes more about risk management than quick gains. Although there are numerous ways to protect your finances, one of the more common ones is diversifying your portfolio.

What does diversifying my portfolio mean?

Diversification is the practice of investing in multiple different areas to limit your exposure to any single type of asset. It is one of the cornerstones of modern portfolio theory (MPT).

What this means is that your investments will vary by things like sector, growth style, or geography. In addition to these, an adviser may have other areas of the market that you could increase diversity in.

By investing in these many diverse areas, you could reduce (not remove) risk during times of economic uncertainty. 

How does that protect me?

You may, at this point, wonder what diversifying your portfolio means for you and your financial plan and how it protects you. There are three main ways that diversification can act as a means of protection: risk management, preserving capital and creating more stable growth.

Risk management

Risk management through diversification comes down to the old adage ‘Don’t put all your eggs in one basket.’ Essentially, the financial theory is that, by spreading your investments across multiple areas, you can mitigate the risk of one investment crashing while others are relatively stable or thriving. 

Although, this is not a guarantee of risk-free investment, it is a widely utilised practice, particularly for those with lower risk tolerances.

Preserving capital

For investors who are closer to retirement, preserving capital is more often the goal than accumulating it is. This means that maintaining the funds you have available is more important than risking it for the sale of potential growth.

Diversification is one way to achieve this. It limits the exposure of your portfolio to single investment losses and you may find that a well-diversified portfolio can support these types of goals better.

Particularly during retirement years, limiting the potential for a single investment going awry and wiping out your retirement funds is key.

Stable growth

Creating a sense of stability in your growth and returns is frequently a desired outcome of a portfolio, especially for those closer to retirement. A well-diversified portfolio should be designed to encourage that stability.

By investing in a variety of assets that react differently to the same economic environments, your portfolio can be more stable. Although you may not see the overall excitement of a single stock soaring, you may also be less likely to see the same wild ups and downs of a single investment. 

It is important to note that this article is purely informational and does not contain any direct advice. Without discussion and understanding of your specific circumstances, risk tolerances and  other requirements, we cannot advise any particular course of action. 

Diversification is one of many options for managing the risk levels of your portfolio. If diversification is something that you are interested in, contact us here.