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Thursday, April 5, 2012 11:00:15 PM
It could seems like a make-work project (now they have more things they have to monitor) or it could seem like additional risk (now conservative investors are stuck with higher risk assets in their portfolio).
However, the truth is that once people understand the most basic benefits to diversifying their investments, they quickly see just how powerful the practice can be (notwithstanding the fact that it becomes a common sense practice as well). Here are two of the biggest and most powerful benefits to diversifying your portfolio:
1. Spread of Risk. By diversifying your portfolio, yes you are adding more assets to it. That could mean spreading out a bond portfolio to include short-term and long-term maturities, government and corporate issues, etc. It can also mean moving some assets out the bond portfolio and incorporating an equity position into the overall investment portfolio.
Regardless of what diversification means, whether it is intra-asset class or inter-class, you are essentially spreading the risk among different assets. This means that if asset A fails you, assets B, C, D, etc. might be able to retain or improve value after all. Spread of risk, therefore, is a fundamental practice that investors can employ to reduce potential losses in their portfolio.
2. Multiple Sources of Income. As in the case above, suppose everything moves along at its regular pace. Asset A, B, C, D, etc. show no signs of risk, but since they are all performing, the investor now gets to enjoy the benefit of different sources of income. Some of that income might come from interest, some from capital appreciation, some from dividends, and so on.
Different sources of income is important, particularly for longer-term investments where income may be sporadic in some asset classes, such as dividend-paying securities and capital appreciation. By enjoying different sources of income, investors are better positioned to be able to continue leading the lifestyle they have chosen.
These two very basic and fundamental benefits truly highlight the importance of knowing and sticking to your asset allocation. And this reality is only heightened during periods of market instability which, like a car whose engine seizes, means it is too late to fix the problem.
The motive behind our investments is to make money and increase our monetary wealth. With so many factors involved, investment decision is a complex one. Small investors often go with their gut feelings when trying to choose among numerous alternatives to invest. Big investors use various analyzing techniques. Globalization and the growth of internet have introduced many new opportunities and threats to ponder upon. When investing, you are committing your assets for sometime, that is why you need to cover all aspects before making an investment decision.
Expected Return:
The most basic investment decisions revolve around the comparison of expected return and risk involved. No investor will take on higher risk if there is no chance of equally higher returns. Investors strive to reach on the best trade-off point between risk and return which go well with their financial requirements. These expected returns are not always equal to what an investor actually gets after some time. The possibility that actual return will not be the same what they expect is called risk.
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However, the truth is that once people understand the most basic benefits to diversifying their investments, they quickly see just how powerful the practice can be (notwithstanding the fact that it becomes a common sense practice as well). Here are two of the biggest and most powerful benefits to diversifying your portfolio:
1. Spread of Risk. By diversifying your portfolio, yes you are adding more assets to it. That could mean spreading out a bond portfolio to include short-term and long-term maturities, government and corporate issues, etc. It can also mean moving some assets out the bond portfolio and incorporating an equity position into the overall investment portfolio.
Regardless of what diversification means, whether it is intra-asset class or inter-class, you are essentially spreading the risk among different assets. This means that if asset A fails you, assets B, C, D, etc. might be able to retain or improve value after all. Spread of risk, therefore, is a fundamental practice that investors can employ to reduce potential losses in their portfolio.
2. Multiple Sources of Income. As in the case above, suppose everything moves along at its regular pace. Asset A, B, C, D, etc. show no signs of risk, but since they are all performing, the investor now gets to enjoy the benefit of different sources of income. Some of that income might come from interest, some from capital appreciation, some from dividends, and so on.
Different sources of income is important, particularly for longer-term investments where income may be sporadic in some asset classes, such as dividend-paying securities and capital appreciation. By enjoying different sources of income, investors are better positioned to be able to continue leading the lifestyle they have chosen.
These two very basic and fundamental benefits truly highlight the importance of knowing and sticking to your asset allocation. And this reality is only heightened during periods of market instability which, like a car whose engine seizes, means it is too late to fix the problem.
The motive behind our investments is to make money and increase our monetary wealth. With so many factors involved, investment decision is a complex one. Small investors often go with their gut feelings when trying to choose among numerous alternatives to invest. Big investors use various analyzing techniques. Globalization and the growth of internet have introduced many new opportunities and threats to ponder upon. When investing, you are committing your assets for sometime, that is why you need to cover all aspects before making an investment decision.
Expected Return:
The most basic investment decisions revolve around the comparison of expected return and risk involved. No investor will take on higher risk if there is no chance of equally higher returns. Investors strive to reach on the best trade-off point between risk and return which go well with their financial requirements. These expected returns are not always equal to what an investor actually gets after some time. The possibility that actual return will not be the same what they expect is called risk.
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