Updated: February 7, 2020
This post is the second part of the series on Personal Portfolio Management. Just in case you missed it, you can read the first part on Asset Allocation here.
One cannot allocate assets without thinking of diversification.
If you follow my age formula in Part 1 – then you’ll notice that dividing your investments in low, moderate and high-risk assets is already an act of diversification.
It is important to diversify investments, or to “put your eggs in several baskets”, to minimize your risks. That is because, if ever one investment performs poorly, your other investments can hopefully, make up for those losses and still net you with a positive balance. Diversification is common in industries like pensions so as to avoid losses, you can read their approach here.
How To Diversify Investments
There are many ways you can diversify, but personally – I consider three factors when doing this. They are:
Factor 1: Risk Category
The three basic types of risk are low, moderate and high. But as you become more financially savvy, you’ll probably begin to consider up to six types: zero-risk, low, moderately-low, moderate, moderately-high and high-risk.
Factor 2: Time Horizon
Just like the risk category, there are three basic time horizons to consider: short-term, medium-term and long-term. Again, as you increase your financial I.Q., you’ll begin to assign exact years in your investments, i.e. 1-2 years, 3-5 years, 6-8 years, 10-15 years, and so on.
If you combine the two factors above, then re-categorize all the assets and investment vehicles which you may want to buy, then you should end up with a table like this:
|risk x time||SHORT TERM||MEDIUM TERM||LONG TERM|
|Cash Deposits||Bonds, UITF, Mutual Funds, Business||Insurance|
|Business, MLM||Business, UITF, Mutual Funds, MLM||Real Estate|
|Forex, Stocks||Equities, Funds||Business, Equities, Real Estate|
Once you’ve done this, you’ll now have a “better map” on how you can diversify while following my age formula for asset allocation.
For example, for your moderate risk investments, you can diversify by investing some of that in short-term investments, some in medium-term investments, and the rest in long-term investments.
If you have P100,000 to invest, the age formula says that you can invest P50,000 in moderate-risk investments. By using the example above, then perhaps you can use P10,000 of that to join a network marketing company; put P30,000 in a balanced fund; and the remaining P10,000 to invest in a real estate investment fund.
Please note that the table above and the examples are just an illustration. Again, personal finance is personal and it’s only you who can really decide how to categorize each investment, and how much you should invest in each one.
Factor 3: Industry Spread
The final, and usually ignored, factor is the diversification of risk among several industries and/or companies. This simply means that you shouldn’t invest in just one company or segment, but in two or more industries so as to lessen the impact of the economy to your investments.
To explain further, let’s say that you want to invest in equities or the stock market; then don’t buy just one company – buy two or three.
Moreover, don’t buy companies which belong in the same industry, instead purchase stocks which belong in different sectors.
This means if you buy stocks of BPI, then don’t buy stocks of another bank as your second company – perhaps consider JFC, which diversifies your portfolio to the food industry.
How about unit investment trust funds and mutual funds? Don’t they provide a good industry spread, thus a balanced and diversified portfolio?
Yes! That’s one of the reasons why many prefer investing in UITFs and mutual funds – because most (but NOT ALL) provide instant diversification of your portfolio.
However, I would suggest that you still diversify by actually investing in different funds from different companies.
This means, if you have an equity fund with BDO, and you have new budget to invest in equities, then maybe get into Philequity Funds this time, for example.
To give you an illustration of how I diversify…
For my high-risk, medium-term investments – I own 3 stocks from three different sectors, and have investments in 2 equity funds – one from a commercial bank and the other, from an investment company.
They’re all in equities if you notice, but they’re spread “like crazy all over the place”. 😛
End of Part 2
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Disclaimer: The investing tips in this post is solely based on personal knowledge and experience. It does NOT constitute as professional financial advice. Consult with a certified adviser to address your specific financial concerns.