Finding a balance between returns and risk is a challenge investors face. That’s why diversification is a useful approach that any investor profile can follow.
In the financial world, investing arouses a lot of interest among lots of people, regardless of wealth or income. They all have the same objective: make returns from the market. But, as markets can be fickle, there’s no magic formula for bountiful investing. Risk is an important thing to consider when investing.
In the past, because investors generally focused on finding high-return opportunities, without too much consideration for risks, they often invested in assets that could cause them to lose all their money. In 1952, US economist Harry Max Markowitz revolutionized investing when he published an article arguing that risks and returns are equally important. He suggested an approach to help reduce financial risk: diversification. Markowitz’s momentous theories earned him the Nobel Prize in Economic Sciences in 1990.
In general, to diversify is to choose more than one thing; in investment, it means apportioning funds among various assets. If one asset takes a loss, the money invested in the others won’t be affected.
How to diversify investment well
Whether you want to start investing or already have experience, you should take some tips on diversification. First, you should choose investments based on the money you have available, expected returns, the risk you can afford to take and the time you’re willing to wait.
Let’s meet Tomás. In recent years, Tomás has been putting some of his wages in savings; now, he wants to invest. He aims at growing his money for retirement in 10 years. He has no hurry or need for liquidity, so he can make a long-term investment. Because he doesn’t want to take up too much risk, he looks for an asset that is safe, even if the returns are low. He can choose among these options to diversify his investment in a way that will help him achieve his goal and reduce his risk.
To find out more about how to get the most from your money, read this article by Sano de Lucas (in Spanish) with pointers about entering the world of investment.
The risk of over-diversification
Diversification without some restraint can harm an investor’s financial health. Too many diversified assets in a portfolio can lead to higher management costs and lower returns. Managing over-diversified portfolios demands more time, and it’s harder to know what’s happening in every industry or region to make decisions about assets.