Module 2 part 5/5: Diversifying
In this article, we explain the importance of diversifying your portfolio.
Welcome to the EasyEquities Mentorship Program, where we make investing EASY for you.
We have prepared 6 modules that we will post on FinMeUp over the month of July.
The modules are intended to give investors the necessary knowledge to start their investing journeys.
Lets get into it!
Diversification refers to not putting all your eggs in one basket (not putting all your money in one place). Simply put, diversifying protects investors against losses.
If an investor has all their money in a single share, the share could crash and leave their portfolio exposed. Fortunately, diversifying is a lot easier than many investors think.
Diversifying is centered around these 3 factors [refer to the image attached]:
Being diversified amongst asset classes means purchasing different types of asset classes. This is by far the most important factor. Examples of asset classes include shares, crypto, property, bonds, and so on.
All asset classes move at different times for different reasons. For example, shares might fall during an economic crisis and bonds might rise because the government might cut interest rates.
In the long-term, a diversified portfolio of asset classes will provide consistent growth at a lower risk than if one invested all their money into one asset class.
Many people only invest in their home country or solely in the worlds largest economies. While it is true that the U.S. stock market accounts for more than 50% of the world's stock market value, this does not mean investors should keep all their money in the U.S.
Most of the worlds fastest-growing economies are in Asia and much of the worlds resources and minerals are in Africa and other emerging markets. Having a portion of the money invested in other countries will potentially increase the growth of investments while also reducing the risk.
Some experts believe that investors should have at least 25% of their investments offshore or even up to 75%. The EasyEquities app allows investors to invest all over the globe.
Diversifying over time is something many investors do not understand the importance of. Diversifying over time refers to investing all your money at once versus phasing your money in overtime (AKA dollar-cost averaging).
The basic principle of diversifying over time is to phase your money into the market over a few months, rather than buying all the shares all at once.
Say you invested all your money at once in the year 1999. This would have been at the final stages of the stock market boom that was later called the dot-com bubble. Many investors suffered dramatic losses and investors that invested all their money at once in 1999, would have taken 12 years to recover their losses!
If they had invested over 12 months, they would have recovered their losses over only a few years. (E.G. R100 000 invested over 12 months would be R8 333 invested every month.)
Time is an investors biggest asset. It is something that cannot be given back. It is also what compound interest thrives on.
Figure 2 [refer to the image attached] is an example of a R250 investment made every month at a return of 10% a year starting at ages 20, 30, and 40: