The meaning of the idiom that says you shouldn't put all of your eggs in one basket instantly becomes clear when that basket is dropped, and all of the eggs are broken. It is an idiom that applies across the world of investing, regardless of what an individual has in his or her portfolio. Concentrating all of one's financial resources on just one or two asset classes is the perfect demonstration of putting all the eggs in a single basket. Should those asset classes fall dramatically, substantial losses become a reality.
Diversification is the answer. Seasoned investors with a track record of success know that diversification is the primary tool used for managing risk. It is not necessarily for growth per se, but growth is an inevitable result of protecting and managing risk appropriately. Diversification limits losses, creates a more stable portfolio, and leads to greater opportunities to invest in assets that would otherwise be avoided without a diversification strategy in play.
Investing for the Long Term
From our perspective, there are basically two kinds of investors: those with short-term vision and those who invest for the long term. Short-term investors are interested in quick returns and maximum value. While it is certainly possible to do well with a short-term investment mindset, it is rare for such investors to maximise their opportunities while limiting their losses over many years investing.
The long-term investor sets goals destined to be achieved over time. A plan is put in place, assets are allocated, and progress is monitored. At the heart of this long-term strategy is diversification. As markets change, the long-term investor's portfolio can be adjusted in order to remain on track as the individual pursues established goals. The primary advantage to the long-term mindset is that a well-diversified portfolio is less subject to volatility.
A long-term investor will put money into numerous asset classes including stocks, bonds, pensions, commodities, and perhaps even property and peer-to-peer platforms. How financial resources are allocated across the different asset classes depends on the investor's level of risk. Subsequently, the amount of growth achieved through diversification is still tied to risk aversion. The more risk the investor is willing to take, the greater the return is likely to be.
Pensions and Investment Portfolios
One of the keys to successful diversification is to choose asset classes that, when combined, align with the investor's risk tolerance. We typically work with four levels of risk, sometimes referred to as 'risk profiles': conservative, balanced, growth, and aggressive growth. All four profiles have room for pension investing as a low-risk option.
We recommend at least one pension be part of every investor's portfolio. Pensions tend to be low-risk assets that, at the very least, will provide some level of income regardless of how the rest of the portfolio does. Investors can then allocate the rest of their resources through diversification that adequately reflects their level of risk tolerance.
For the record, pensions are a staple of the long-term investment strategy. A pension is typically the first place a new investor will put money; it is a tool through which many investors who go on to enjoy long-term success actually learn how investing works.
Diversification and Portfolio Adjustment
It should be noted that diversification is not a one-off strategy that can be employed and then forgotten about. The fact is that markets and asset classes change over time. Right now, a portfolio might be enjoying exceptional growth with a heavy concentration in stocks and shares. Even while bonds are losing, those stocks and shares are more than making up the difference. But what happens when stock markets drop?
The investor must always be at the ready to shift assets around in order to accommodate the ebb and flow of the markets. When a bear market appears to be on the horizon, money should be shifted out of stocks and shares and put into something more stable. When stock markets are bullish, that is the time to shift more resources into them.
Any investor who intends to maximise growth over an extended period of time should give no question to the idea of diversification. It is not a matter of whether one should diversify or not but, rather, how to diversify in a way that matches one's risk tolerance. Diversification is the key to long-term investing because it limits losses and provides for more stable growth within one's risk profile. If you are not diversified, your portfolio is at risk.