In my previous post, I talked about the risk of investing crossing over into gambling; diversification is one of the best ways to prevent that from happening.
Gambling is all about putting all your eggs in one basket, betting the pot on one result, whereas diversification is about spreading the risk so that if one investment goes sour, you have other investments in other areas that can cover the loss.
One of the main keys to successful investing in starting with the end in mind. What I mean by that is, strong and successful investors know before they begin, what the outcome is that they want to achieve. If the aim is to create an income for retirement then the fund will need to be made up of the safer assets available, like bonds, property and cash, funds that have a low loss rate. If the aim is to generate income now, or your preference is a higher risk, then stocks, options and futures etc will be a better fit.
Whatever the preference, remit or style of your investing, the key is to know what you want to do before starting, and then ensuring you don’t invest in just one area.
But let me explain why diversification when investing is important.
Let’s say you were to put all your money into property development. This is something a lot of people did pre 2008 and when the housing market collapsed, their investments disappeared. Or imagine if your portfolio is made up only of stocks in the oil industry, with the price of oil continuing to fall right now, your portfolio would be looking rather depleated with no view of a recovery in sight. But if you had some of your portfolio in oil and some in renewable energy, then when one is down, the other prevents you from losing everything.
The best type of investment diversification is spreading your investments across a multitude of investment types and industries. So if you go for a mix of stocks and mutual funds or ETF’s then also diversify further by spreading them across different industry types like construction, transport, health sector and so on.
Diversification is the best way to protect yourself from mass loss. It is not a completely fool proof way, nothing is, but the more your diversify by putting your investments in many baskets compared to putting all your money in one basket, the more you protect yourself when one basket is hit. Every person I have ever coached, worked with or talked to who lost everything, did so because they put everything into just one or two investments. Everyone who I speak to who has diversified their investments suffers the odd loss now and again, but I never see them panic, because they have that safety net that is diversification, in place.