As a beginner investor, you may not be very familiar with the term “diversification.” In reality, experts or experienced investors often recommend diversification for others, especially for novice investors.
The emergence of diversification as a recommendation is not without reason. Diversification is one of the investment strategies and a powerful tool for maximizing profits. On the other hand, diversification as a ‘powerful tool’ is primarily applied to minimize risk, although no one will argue that diversification can also maximize profits.
You may often hear the phrase, “Don’t Put All your Eggs in One Basket.” From any perspective, this phrase carries a deep meaning. In investment, it means “Don’t allocate all your assets to one investment instrument,” which is the true meaning of ‘diversification.’
Investment Diversification, Expert Recommendations – Every investor wants to achieve significant profits with increasing capital through long-term investments or short-term investment products. However, a proper strategy is still needed to increase the value of the invested funds. One way to do this is diversification, a process still recommended by experts.
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What is Investment Diversification?
Diversification is a term well known to investors, meaning diversity in investments. A common saying associated with diversification is not putting all your eggs in one basket. If you want to invest, do not invest in only one instrument. In essence, investors create a diverse portfolio to avoid losses.
Portfolio Diversification Reduces Investment Risk
For example, consider stocks issued by a company.
If the value of the company’s stocks continues to decline or weaken, your investment will also decline, and the investment value will not grow. Separating assets by buying two stocks from different companies will reduce the risk of losing your portfolio value, and your investment will be safer. In other words, diversification is a strategy for placing investment funds in different instruments.
Here, instruments refer to their liquidity, risk, and potential returns. For example, the possible return on investment in stocks will differ from that in bonds. In essence, the return value of stocks is higher compared to bonds.
However, the risk of investing in stocks is much higher than in bonds. This is because the fluctuation in stock prices is more significant, leading to greater risk. Moreover, liquidity refers to the ease of buying and selling an investment instrument.
The most suitable example is property investment. If you advertise your property or house, it may not necessarily sell immediately. It could be sold tomorrow, next week, or next month. It differs from stocks, which can be traded on the same day if desired, allowing immediate profits.
Steps to Diversify Your Investment Portfolio
To diversify effectively, avoid investing in instruments with similar characteristics. For example, in a stock mutual fund, you allocate your portfolio to blue-chip stocks with the expectation that their returns will not differ significantly.
It should be noted that every fund manager has a different recipe, and investing in more than one type of stock mutual fund is possible. However, it’s important not to buy too many similar mutual funds.
Now, to simplify the diversification of your investment portfolio, what steps should you take? Here are five essential steps for diversifying your investment portfolio that can help you diversify your assets to expand your diversification.
1. Understand Your Risk Tolerance
When we talk about risk tolerance, we’re referring to the level of risk we can accept and the minimum level of risk we can take. Investments may not be maximized without considering profit potential, understanding how the chosen investment instruments work, and referring to investment funds ready to be invested.
So, first, understand your risk tolerance.
2. Determine the Assets Ready for Investment
Achieving the right balance between financial goals and risk tolerance will help you determine your investment target in expanding your portfolio. Usually, investors with a high-risk tolerance will invest in marks with a higher risk-return profile. Investors with lower risk tolerance will seek safer investment instruments such as Retail Government Bonds (ORI), low-volatility stocks, and money market mutual funds.
To achieve maximum benefit from diversification, investors must allocate some of their portfolios to uncorrelated asset classes. These investments have historically had low dependencies on each other’s returns.
3. Regularly Rebalance
Rebalancing is when investors align or balance the weight of assets invested in the investment portfolio. In terms of stocks, for example, rebalancing can refer to activities involving buying or selling assets in the portfolio to maintain the desired asset allocation.
For example, an investor’s investment portfolio has an asset weight breakdown of 50% in stocks and 50% in bonds. If the stock price performs well at some point, the investor may increase the stock weight to 70% in their portfolio.
The investor may sell some of their stocks and buy bonds to rebalance their investment portfolio to a 50/50 balance. Adjusting the target allocation in your investment portfolio will help ensure that your portfolio aligns with your risk tolerance, investment needs, and financial goals. On the other hand, deciding not to adjust the weight will increase your investment risk.
4. Understand Risk Capacity
Emotional willingness and your capacity to bear risk often conflict. As an investor, you may take on more risk than you can handle. Or, in your investments, you may have a conservative nature while occasionally needing to take more aggressive steps.
Various factors, such as the weight of funds in savings, the value of assets in investments, and financial goals, will determine an investor’s risk capacity. Therefore, it is essential to understand the extent of your risk capacity.
5. Focus on Long-term Financial Goals
When managing your investment portfolio, use various approaches such as balance, discipline, and the long-term to make your investments more focused on long-term goals.
Sometimes, we are tempted to invest in the ‘best investment types’ recommended by experts or even drawn by ‘investment types that generate profits’ without ever considering whether those investment types can support us in achieving long-term financial goals.
If you are approaching retirement, you must consider what type of investment is suitable to help meet future retirement funds.
Regardless of the type of investment you want to try, ensure that type is suitable for your risk tolerance and financial goals. Focusing on long-term financial needs and goals will help you survive through turbulent times, help grow assets, and maximize profits from your investment portfolio diversification.
These essential steps to make it easier to diversify your investment portfolio above can at least provide an overview when you want to diversify your assets into various investment instruments. Doing so will give you an idea of how you should plan to diversify your investment funds.
Suppose you have been investing in stocks and bonds, for example, by understanding risk tolerance and capacity and determining long-term financial goals. In that case, you may find other investment types that suit you, such as deposits, money market mutual funds, or government bonds. If you’re unsure, you can first learn the fundamentals with funding from KoinP2P from KoinWorks.
KoinWorks is an application that provides financial solutions ranging from asset development through funding to business or individual loans. With just Rp100,000, you can allocate your funds to borrowers, including SMEs in Indonesia. This small amount can allow you to diversify your investment portfolio more.
