Hey there! Money speaking!
As we already established, being me is tasking, and the events of last week definitely did not help. Two of the most popular tech founders in the world fought over me, and I am sure we already know the path I am treading.
Mark Zuckerberg launched Threads last week, a competitor to Elon Musk’s Twitter, and users flocked to the new app in droves. In essence, diversifying their content consumption channels due to a dip in Twitter’s user experience.
Why am I using social media in a conversation about diversification? Well, my friends at Zedcrest Wealth always want me to simplify complex ideas, and you would not fault me if I presumed that you had TikTok, Instagram, Twitter, Threads, Snapchat, and Facebook on your phone.
With social media, you already practice diversification, and if we look at investment options as social media applications, this should simplify diversification through the lens of wealth management.
So, what is diversification?
Diversification is a comprehensive investment strategy that focuses on the dispersion of investments across a wide array of assets, asset classes, sectors, or regions with the primary objective of mitigating risk. It is built on the fundamental principle of avoiding overexposure to any single investment, emphasizing the importance of diversifying across multiple avenues.
For example, during the COVID-19 pandemic, companies in the consumer goods and healthcare sectors saw significant value growth, while companies in aviation and hospitality saw value decline.
Why Should You Diversify?
Simply put, nobody knows tomorrow. Diversification reduces the risk of you losing most or all of that money to market fluctuations in one investment class. The essence of diversification is to put money in asset classes that are not perfectly correlated, such that when one asset class increases, the other decreases, or is not affected at all.
Consider the scenario where you implement a diversified investment strategy by purchasing 100 units of shares in Bank A at N100 per share (market value = N10,000) and an additional 100 units of shares in Tech B at N100 per share (market value = N10,000). Consequently, the total value of your investment, comprising Bank A and Tech B shares, amounts to N20,000.
Now, let’s fast forward three months. During this period, the price of Bank A shares has risen from N100 to N150 per share (market value: N15,000), indicating a favorable trend. However, the price of Tech B shares has declined to N90 per share (market value = N9,000). Despite the decline in Tech B shares, the overall market value of your investment has increased to N24,000.
In contrast, if you chose to invest your entire N20,000 solely in Tech B shares, you would have encountered a different outcome. At the end of the three months, your investment in Tech B would have declined to N18,000, resulting in a loss of N2,000.
It is important to note that investment outcomes are subject to market fluctuations and individual stock performance. So, while diversification reduces risk, it does not guarantee profits or shield against losses. However, by embracing a diversified approach, you position yourself to achieve long-term investment success.
A form of diversification called geographic diversification involves spreading investments across different regions or countries that can help minimize currency risk.
How to Build a Diversified Portfolio in Nigeria
A portfolio is like a suitcase of investments, and here are tips on how to make sure your bag is well-diversified:
- Recognize your investment goal: your money can be invested for growth, income, or capital preservation. Knowing your investment goal helps you determine your risk tolerance and the types of investments to diversify into. So if your goal is regular income, fixed-income investments are generally best, but you can diversify into sovereign bonds, corporate bonds, Treasury bills, etc.
- Use of asset class diversification: This involves allocating investments across different asset classes like stocks, bonds, real estate, commodities, and cash equivalents.
- Use of sector diversification: This entails investing across sectors or industries, such as technology, healthcare, finance, consumer goods, and energy.
- Use of time diversification: This involves allocating investments across different time horizons, considering both short- and long-term goals.
- Use investment vehicle diversification: This involves using different investment vehicles, such as stocks, bonds, mutual funds, ETFs, and alternative investments.
It’s important to note that diversification does not eliminate the possibility of losses or guarantee profits. It is a risk management technique that aims to reduce the impact of specific investment risks.
Proper diversification should be based on your risk tolerance, investment objectives, and time horizon. Consulting a financial advisor is recommended to design a diversified portfolio aligned with one’s specific needs and goals.
