Starting to invest can be an intimidating and stressful process. We have all heard stories about market corrections, crashes and even the occasional Ponzi scheme where one becomes a victim of fraud. While investing will always carry a certain level of risk, properly diversifying will not only help reduce the risk, but allow your portfolio to sustain pressure from various market conditions. The primary benefit of diversification is that it reduces the volatility (risk) of your portfolio. If one investment goes down in value, another may be going up at the same time so that overall performance remains positive over time. Before we get into the details of how to properly diversify, let us understand what diversification really means.

What is Diversification?:

Asset diversification is defined as a financial strategy that involves spreading investments across different asset classes, industries, or geographic regions to reduce risk. The goal is to limit exposure to loss in any one investment or type of investment. In other words, diversification involves investing in a variety of different places to try and reduce your overall risk. As they say, “Never put your eggs in one basket”

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Steps to properly diversify

Now that we understand what it means to diversify, the next step is to understand how to do so effectively. Diversification comes in many forms, and it is important to understand each of them to achieve the goal of being well diversified.

1.      Asset Diversification:

Each of type of investment can be broken down into an “Asset Class’’. Assets that belong to the same category, exhibit similar characteristics and are generally subject to the same laws and regulations. Each asset class will generally have similar levels of risk & tax treatment. Due to the unique nature of each asset class, it is important to have a careful blend of various assets classes to limit the risk. Examples of some asset classes include:

⦁  Equities: Stocks, ETF’s etc.
⦁  Fixed Income: Bonds,
⦁  Cash and Cash Equivalents: GIC, HISA, Treasury bills etc.
⦁ Private Equity
⦁  Real Estate
⦁  Insurance Products
⦁  Cryptocurrency

Including different asset classes in your financial plan, will allow you to not only take advantage of varying levels of risk, but also take advantage of different tax treatment.

2.      Geographic Diversification:

Some investors may suffer from “home-country bias” when choosing investments for their portfolio— for example, buying shares in companies they know that operate in their home country. This can leave you at risk to local economic downturns, currency devaluations and political risk. It can also limit your investment choices. For example, here in Canada, we have a higher concentration of energy and financial stocks than many other countries. Canada also accounts for less than 5% of the global investible universe, which means you may miss out on some good businesses by only investing in Canada and Canadian firms. Finally, any political or local economic instability can have a serious negative impact on your portfolio should you solely be focused in one jurisdiction. To reduce this risk, you should consider adding exposure from various regions globally.

3.      Sector and Industry Diversification:

Companies in certain industries may perform differently depending on different economic conditions or stages of the business cycle. As an example, a sector that uses a lot of leveraging, such as real estate, could benefit when interest rates are low, but suffer as rates rise. Similarly, potential labour shortages or sector specific supply chain issues may cause an entire market sector to suffer. It is therefore crucial to have exposure to several major sectors could reduce the impact of a single sector pulling down a portfolio.

Want to know more?

Creating a well diversified portfolio involves many moving parts. In addition to the items above, it is important to understand you level of risk, time horizon and overall investment style. Each investor has different goals and therefore their portfolio should match those specific objectives. Diversification is one important way to ensure you stay on track with those goals and to help navigate during times of volatility and uncertainty. Contact your team at Oberoi Financial Group to allow us to ensure your portfolio is properly diversified to help you achieve your long-term financial goals