Why is it important to diversify your investments?
Preserving wealth may be less exciting than generating it, but a balance between the two approaches is widely-considered to be one of the most important aspects of long-term investment.
While wealth generation aims to maximise market highs, wealth preservation comes down to protecting your investments from the lows. One of the best ways to achieve this is by diversifying your investments across various assets, which spreads the risk across your investment portfolio as drops are mitigated by stable and rising assets.
The experts call this healthy balance of investing across a broad spectrum of investments a balanced portfolio.
To illustrate the point, let’s look at how diversification is put to work in the equity market.
If you invested $10,000 into a company stock, let’s call it Stock A, and its value halved overnight, it would leave a substantial crater in your investment.
But, if you spread your $10,000 between five companies, the damage from Stock A’s fall from grace would be offset by your investment into the other companies.
The same applies to cryptocurrency investments. If you put all your eggs into Bitcoin or Ethereum, or whichever other cryptocurrency, there’s a risk that the value of your investment relies too heavily on the performance of the one. If Bitcoin’s having a bad day, the value of your investment’s going down with it, but spreading your investment between three or four or five coins breaks up this risk.
How do you spread risk?
It comes down to both the timing of your investments and what you invest in.
Diversification applies to every level of the investment journey. There is diversification at the top level, between the different asset classes: currency, commodities such as gold, property, equity, digital assets, and so on.
Then there is diversification at the lower level, within each asset class. In your equity investments, for example, it’s common to put your money into a number of different companies operating in different sectors rather than just pouring all your savings into one company stock.
Dollar cost averaging
The frequency with which you invest also impacts the risk exposure of your investment. Many financial professionals advise that investors phase in their investments rather than investing it all at once.
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