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In view of the current fragility of the markets, a sensible strategy to minimize
risk is to diversify. The most straightforward way for investors to diversify is
by spreading their investments across several different securities. Diversification
is beneficial to investors who want to avoid excessive risk.
Through diversification one is able to achieve targetted returns at the same time
is able to expose themselves to less risk. Diversification works for investors because
returns on individual asset classes ie property, fixed interest, stocks are not perfectly
correlated over time. Some may rise more while others may fall, they almost never
work in tandem.
During a drastic market downturn, although a portfolio with a diversified range of
assets does not guarantee that you will not lose a single cent, it helps minimize
the losses. Losses from one class of asset will be offset by gains in another.
In this current market situation, if you have been holding a balance of say stocks
and fixed deposits, your losses in stocks may be compensated by higher interest rates.
The compensation effect works even better if you had diversified more with investments
in other form of investments. Investors should always consider diversification regardless
of market trends.
For investors who have been investing and whose original investment portfolios are
skewed towards stocks, it is time to reexamine your portfolios in relation to your
objectives. Investors should review their asset allocation at least every six month
and adjust according to market conditions.
The plummeting stocks should lead to a need for a more cautious approach to investments.
For some investors, a reduced exposure to stocks and increased holdings in cash-based
investment vehicles is appropriate. This will help to negate any extreme stock movements.
However, it is not necessary to over react and "dump" all you own. It could
still be viable to hold investments that have sound fundamentals.
For others with likely uninterrupted disposable income such as public servant, doctors,
accountants, and professionals now is the time to consider taking a counter cyclical
approach and investing long-term.
Every investor should be aware of the benefits diversification can offer and the
relationship between risk and return in an investment. It is reasonable to expect
a higher rate of return from an investment that is more volatile in nature such as
stocks, investments such as bonds provide lower and more stable returns.
When markets are unstable, investors should opt for investments that are not
correlated to each other. A balanced mixture of cash, bonds, stocks and property
should be able to minimize losses compared to a portfolio with more than 60% total
holding in stocks.
In other words, by holding different class of assets accordingly, the risk can be
systematically reduced.
In a nutshell, diversification improves the risk/return trade-off if investments
selected are not closely or perfectly correlated.
Stockmarket can be a volatile arena. Risk, the dominant consideration for investors,
can be reduced if one practices discipline and diversification. Owning more than
one type of asset can produce a risk-return trade-off that would be preferred by
many risk-averse investors.
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