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Making Diversification work for you
With every endeavour you embark upon in life, whether you’re driving your car, purchasing your
first home, or even crossing the street, you expose yourself to a certain degree of risk. The
Oxford dictionary defines risk as, “Chance of bad consequences.” This is a part of life.
Do you take vitamins on a daily basis, go on a diet from time to time, or pay insurance
premiums on your car, your home, your life? Well, all of these are risk management strategies.
Every aspect of our lives involves risk and trying to run from it is just as easy as trying to run
from your shadow. Some situations are high-risk, some are low-risk and some are in between.
Just because a situation might currently be a low-risk one or a high-risk one, does not
necessarily mean it would be characterized like this indefinitely. Therefore, any random activity
may very well expose you to varying degrees of risk dependent on what risk management
strategies that you have put in place.
A very effective and common risk management strategy is, ‘Diversification.’ To diversify means
to introduce variety and so the term ‘diversification’ means essentially that; the spreading out of
your investments through the introduction of a variety of instruments.
Let’s examine its
effectiveness by looking at 2 different scenarios. These scenarios are common situations which
will help us to better understand the advantages of diversification in our own investment
portfolios and plans.
Let’s examine scenario one. It involves a business-man who has captured a large market share
by establishing brand loyalty in his industry over time. Because of his current success, he is
inclined to reinvest any and all resources into his line of business. However, because this
business-man has basically ‘put all of his eggs into one basket’, his resources are not
diversified. Therefore, any event that adversely affects his line of business, presents the risk of
a severe dent in his profit margins and possibly even the failure of his business. His colossal
entity and his spending power may be substantially affected and the ultimate risk of total
business failure may move from very low to very high. To illustrate this point, allow me to make
reference to the national community which was recently faced with grave difficulty in attaining
U.S. currency. If the cash holdings or main operations of a businessman related to this issue
were not properly diversified, resulting in an over-dependence of U.S. currency, this hiccup
becomes risky as it can hamper operations and negatively affect profitability. A diversified
portfolio consisting of both local and international investments may very well reduce the
associated risks of the overall investments of such an investor.
Now let’s look at scenario two. Our little island is well endowed with hydrocarbon reserves which
have been a major component of our economic growth. It is however a known fact that there is
mounting concern with just how sustainable the energy sector would be in the near future. An
over-reliance on energy without strategic diversification presents a risk to our economy, a risk
that will grow higher over time if attention is not given to economic diversification. Similarly, on
an individual level, an investor who invests all or a large portion of his/her money into this or any
sector through a stock or even a mutual fund, increases the probability of loss in the value of his
investments due to disruptions in that sector. Diversification across various sectors helps to
mitigate this risk.
In summary, diversifying does not eliminate risk, but it does however mitigate it. Essentially, the
term ‘diversification’ encompasses the old saying, “Don’t place all your eggs into one basket.”
This prudent practice involves the spreading of risk by investing across a variety of investment
vehicles and asset classes. Though it is one of the most fundamental risk management
strategies, it is largely overlooked by many investors. Investments in each of the different asset
categories outlined below serve to reduce risk and increase expected returns. A knowledgeable
advisor would usually encourage you to employ a decent mix of these:

Stocks assist with portfolio growth.

Bonds generate income.

Real estate provides both a hedge against inflation and low "correlation" to stocks -- in
other words, it may rise when stocks fall.

International investments provide growth and help maintain buying power in an
increasing globalized world.

Mutual Funds are the most cost effective way to incorporate all above

Cash gives you and your portfolio, security and stability.
Finally, fostering an open and healthy relationship with an experienced and well qualified
investment advisor can help you to achieve your investment goals. Remember, you are
responsible for your financial fate. You work hard for your money, and by prudently
implementing a well-diversified portfolio, there’s a very good chance that you can cause your
money to also work hard for you.
Candace Renwick
11th June, 2014