Financial diversification is good

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Diversification can bring big benefits

The need for strong diversification within your investment portfolio has never been stronger.

The world is changing very quickly.

Escalating innovation and new technologies will have a disruptive effect on many businesses.

Taking that into account, an investment you currently have in your portfolio may be a company that will soon become obsolete.

Not convinced?

Remember the financially sound high-tech company, and the Canadian darling, named Nortel?

For many years, Nortel was the pride of our country, flexing its technological muscles in a competitive world.

Nortel was a ticket to financial wealth. 

Right up to the time it crashed and burned, and the stock plummeted from well over $100 per share to virtually nothing.

Many historic investors watched a significant part of their net worth evaporate as they proudly waited for their Canadian creation to make its recovery.

Diversification is your friend because you have no way of knowing, in advance, which investments might suddenly decline in value.

The best defensive strategy against those kind of losses is to spread the risk as much as possible.

Generally, the more money you have, the more you want to ensure your capital is protected. The older you are, the more you want to protect your capital because you have fewer, or no, remaining years in which to earn money to replace those losses.

We know from studying the effects of diversification that an internationally diversified portfolio has a better chance of providing a stronger return with less risk.

Diversification meanings owning lots of different investments, in different industries, with different customers, and located in different countries.

There are thousands of good investments that provide this type of diversification.

Many investors concentrate their investments within one economy, which is to their detriment.

Research in behavioral finance shows that investors experience far more pain with an investment loss, than they get financial satisfaction with a gain of an equal amount. In other words, they really dislike losing money more than they enjoy making it. They are loss-adverse.

But humans are also greedy.

In theory, everyone should diversify. In practice, many don’t because human behavior motivates us to pick ‘winners’ and invest in those winning stocks. Why buy a diversified portfolio when you can buy the 10 best investments?

That is a contradiction. It’s hard to have an investment portfolio that satisfies the two conflicting needs of loss-aversion and greed.

Why have a safe portfolio when you really hope to be able to pick the next Apple stock and make a fortune? Just to refresh your memory, several years ago Apple was very close to going out of business.

For those of you who do not diversify your investments, why is that?

We have seen lack of diversification decimate portfolio values in the past. That risk is real and ongoing.

A strongly diversified investment portfolio will not negate your chance for financial success. As stated above, there is evidence that strongly diversified international portfolios produce higher returns with less risk.

For those who do incorporate diversification, you have evidence and research on your side.

For those who have concentrated positions, why do you choose to ignore all the benefits that strong diversification offers?

 

Peter Watson is an agent of, and securities products provided by, Aligned Capital Partners Inc. (ACPI).  ACPI is a member of the Investment Regulatory Organization of Canada (www.iiroc.ca) and the Canadian Investor Protection Fund (www.cipf.ca).  Peter Watson provides wealth management services through Peter Watson Investments.