Superseding volatility: Managing investment risks
Tim Aldiss writes for Shadow Foundr: don’t just follow the crowd, follow experienced investors.
An investment portfolio can be thought of much in the same way as a boat sailing upon the ocean. Should the seas become rough, the boat will founder if it is not handled correctly or it is imbalanced. The marketplace can be just as volatile and unforgiving. This is one of the main reasons why it is so very important to spread your financial risk across different sectors and assets. Let’s take a look at this concept in a bit more detail to appreciate the true benefits of diversification.
What Goes up Can and Will Come Back Down
This is not an opinion, but rather a fact in reference to any holding. Let us assume for a moment that you are keen on short-term and (potentially) high-yield investments. Binary trades, CFDs and Forex pairs could be quite appealing. However, placing all of your assets in one financial “basket” will prove risky. Should a massive loss occur, you will be left in a precarious position. This is even more relevant for those who regularly employ leveraged trades. Spreading your finances into other sectors such as blue-chip stocks, commodities and managed funds can help to offset such a situation.
While there is no doubt that the major appeal of any investment is the capital return involved, the fact of the matter is that a number of different positions could be able to provide you with a source of sustainable wealth over time. This is actually the goal of many investors from the very beginning. Once again, pragmatism and prudence should always rise above “gut feelings” or shifting massive amounts of capital around into a single position.
It is a fact that the majority of single investments will sooner or later fail. Think of the recent housing crash or the price of gold between 2011 and 2015. The values of both of these sectors fell massively and should you have only had holdings in these, your investments would have been severely damaged. This is another reason why diversification is so very important. Should an asset or even an entire index fall, your other holdings will be able to make up for short-term equity losses.
Now that we have a basic understanding of the reasons why diversification is crucial, how are you to know where to place your finances? The truth of the matter is that the answer to this question has just as much to do with your personal preferences as it involves the amount of funds that are available. However, here is a typical example which could help you to discover what works for you:
- 20 per cent in blue-chip stocks.
- 20 per cent in commodities such as oil or precious metals.
- 20 per cent in up-and-coming domestic technology companies.
- 15 per cent in managed funds such as pensions or an ISA.
- 15 per cent in tangible assets such as property.
- 10 per cent in liquid positions such as currency pairs.
This well-balanced example is diversified enough so that if a drop occurs in one sector, it could be nullified by a rise in another. We should also note here that the most liquid positions equate to the smallest percentage of the portfolio.
Diversification is indeed the key to long-term financial success. This conservative approach is a great way to enjoy a source of liquid capital when it is required for your personal or professional needs.