Easter is just around the corner, and it’s a great reminder that in investing, as in life, it’s best not to put all your eggs in one basket. Diversifying your investments balances risk. No single investment can be a top performer all the time and in all economic environments. Dividing your money into different investments can help create steadier returns in the long term.
The recent economic downturn Alberta has suffered illustrates just how beneficial it can be to spread out your investments. As little as two years ago, investments in the oil and gas industry were generally doing well. Since then, those whose eggs (investments) were all in the oil and gas basket have watched their value drop with the price of a barrel of oil. Those whose investments are diversified are less likely to lose everything due to a downturn in a particular market. Even when their investment(s) in a particular sector loses value, their investment(s) in unrelated sectors may be unaffected or even become more profitable.
Historically, it’s never been a good idea to have your entire portfolio concentrated in one industry. We’ve seen the technology bubble burst, the real estate market collapse, and political turmoil and natural disasters around the world cause instability in the financial markets. Unlike in Alice in Wonderland (another story with a famous rabbit), the looking-glass into the future doesn’t exist. Everyone who invests is taking on a degree of potential risk (the nature and/or timing of which may not be easily foreseeable), so it’s best to mitigate it.
There are many ways to diversify your investments, beyond just splitting them between different industries. You can have both long-term and short-term investments (time diversification). You can split them between different types of investments, for examples, stocks vs. bonds (asset classes). As well, consider different investments within each asset class, for example, stocks in company A and company B. Your own specific mix of investments should take into account your risk tolerance, time horizon (to, for example, buying a house, financing a child’s education, or retiring), and other factors.
It’s equally important to review your portfolio to make sure the combination in it still matches your investment goal. Over time, some of your investments may grow faster in market value than others, leaving you with more invested in a higher (or lower) risk opportunity, or particular industry, than you originally intended. As a result, the proportion of different investments may become off balance from your original mix. Also, changes to your life, career and financial situation may mean your investment goals are no longer the same as they were when you set up your portfolio. Why not use Easter as a reminder to “spring clean” and rebalance (if necessary) your portfolio for diversification once a year?
How do I know which investments are right for me?