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Three kinds of diversification

POSTED ON January 27, 2020

When it comes to investing, one of the most common pieces of advice is, “Don’t put all your eggs in one basket.” In other words, diversify.  The logic is simple: Invest in more than one kind of investment to distribute risk. If one or two investments don’t do well, the others still might. 

Here are some of the most popular ways of diversification:

Get defensive stocks

Out of all the asset classes, stocks are the ones that match high risk profiles. While all stocks ride the ups and downs of the market, some aren’t usually as volatile as others. These are called defensive stocks.

Note that not all blue chip companies are defensive. Blue chip companies are the top 30 biggest companies in the stock exchange. However, many of these companies are responsive to shifts in the economy.

Defensive stocks are from companies that provide what people always need, like water, electricity, and telecommunications. Whatever shape the economy is in, people are likely to spend on these.

Meanwhile, some industries are the first to be affected when people need to cut back on spending. Examples of these are companies that are in real estate, banking, and electronics. After all, if money is tight, you won’t want to buy a new house or get a loan, but you’ll still need to keep the lights on and the water running.

Mix and match asset classes

Even if you’re being defensive, investing purely in stocks can be risky. Defensive stocks are not completely immune from changes in the industry or economy. One way to lower the risk is to invest in other asset classes.

If have stocks, you might want to look into bonds as well (you can get them for as low as P5,000). While stocks mainly grow through capital appreciation, bonds grow your money through interest. So, if your stocks are down, the bonds will still give you coupons.

You can also try unit investment trust funds or mutual funds that contain both stocks and bonds.

Something else to think about: get assets that move differently. For example, you buy stocks in an exchange-traded fund that tracks the stock exchange. Then, you invest in a mutual fund that also tracks the stock exchange. Since they both behave the same way, your portfolio won’t be diversified even if they’re technically different asset classes.

Tap into the global market

An advanced way to diversify is by investing in foreign assets. For example, if you feel like Philippine stocks won’t do well, you can invest in stocks of well-known US companies. Or you want to buy bonds but feel like the interest rate in the Philippines is too low, consider bonds from Japan.  

Of course, investing in foreign assets brings new kinds of risk. Besides being exposed to foreign exchange, you’ll have to deal with the performance of foreign economies too. If you’re going to try this kind of diversification, be mindful of these risks. Take note as well that there could be higher fees involved compared to investing locally.

Diversification helps protect your investments while allowing them to grow. It’s all about investing in the right mix that matches your risk profile. Whether you’re an aggressive investor who wants to lower risk or a conservative who wants a bit more growth potential, diversification could be the change your portfolio needs.