Variety is the spice of good returns

Wiehan van Zyl, Portfolio Manager at Momentum Securities writes about the importance of having a diversified investment portfolio

As an investor and a financial advisor, it is important to understand and always review your investment portfolios and ensure that they are well diversified.

The markets have been turbulent since COVID-19 began ravaging economic activity, and this has made it difficult for investors to anticipate future market movements.

Most investors are aware that they need to have a well-diversified investment portfolio by now. In case you need a refresher, remember that portfolio diversification is critical to reducing the impact of market volatility. That’s the theory, but I know that many find it difficult to put it into practice. As an investor, it is both your responsibility and your financial advisor’s responsibility to ensure that your investment portfolio is well diversified.

This can be done by investing your assets across different industries, focusing on spreading the risk between cyclical and non-cyclical industries.

True portfolio diversification is achieved through selecting and holding different asset classes, rather than individual stock-picking and market-timing.

There are several types of asset class categories that investors may be interested in pursuing, but be careful and ensure that you understand what these classes are and what types of assets lie within those groupings. This is particularly related to fixed-income investments, cash and cash equivalents, real estate, stocks, equities and futures and other derivates.

Remember that well diversified portfolios can be costly to an individual. Another approach to creating a diversified portfolio is by focusing on geographical diversification. Geographical diversification is a way of reducing portfolio risk by avoiding excessive concentration in any one market. This can involve investing in developing countries that offer greater growth potential than developed economies.

Be warned, you will encounter risks such as unfavourable currency fluctuations and unstable political systems. With that in mind, the benefits may outweigh the risk as the global economy offers different opportunities at different times, especially when your portfolio is geographically diverse.

At the end of the day, a diversified portfolio minimises the overall risk associated with investing. Since investment is made across different asset classes and sectors, the overall impact of market volatility comes down. Owning investments across different funds ensures that industry-specific and enterprise-specific risks are low. Therefore, it reduces risks and generates higher returns in the long run. A simple lesson, but one that many investors often forget to explore.