Diversification? What is it? How is it actually for you as an investor or entrepreneur? 

You would have surely heard a lot of the importance of diversifying your investments or business from the media and people in general.

However, do you really understand the process of diversification for your investments or business? Is it just as simple as buying as many different companies to reduce your risk? Or investing in as many businesses as possible to generate more income streams?

This article will explore what are the realities of the diversification process for you as an investor or entrepreneur. The first 4 points will touch on the investor side of you and the next 2 points will explore what it means for the entrepreneur side of you.

Investor #1: You Don’t Need A Lot of Money To Diversify

Contrary to popular belief, you don’t actually need a lot of money to successfully diversify your investments. The amount of financial products in the market now has made it easier for anyone to be invested into all sorts of asset classes.

Before this, you would have heard about the rule of investing in at least 20 or more stocks in the market to effectively diversify your investments. As you would need to buy one lot of shares (100 shares) for a company, this means that you would need to put in at least RM300 to buy. Multiply that by 20 companies, and you will need to put in at least RM6000 to diversify at the minimum level.

Today, you have access to a myriad of financial products and platforms that diversify your investments without the need for high amounts of capital or worry. You can explore the following products that do the job better, cheaper, and faster:

  1. Exchange-Traded Funds: These are investment funds that are freely traded in the market which give you exposure to almost all stocks and companies. You can freely buy an exchange-traded fund on your stockbroking platform, just like how you buy an ordinary stock.
  2. Robo-advisors: Exactly what it sounds like. Robo-advisors help you invest your money according to your preferences and financial goals, and they do so by investing in many different assets in the market. You just put your money in and set your preferences and they will do the rest for you in terms of investments. Some robo-advisors have a minimum deposit but they usually don’t exceed RM100.

Investor #2: Diversify According to Your Risk Level and Preferences

There isn’t a one-size-fits-all diversification strategy for everyone in the market. While investing in all asset classes counts as diversifying against all risk, that usually isn’t what you are looking for. It ultimately depends on how much risk are you willing to take and the preference you have for the investments you want.

This will depend on your age now as you would have different financial goals at different stages of your life.

If you are in your 20s and early 30s, you have a longer investing time horizon so you can take much higher risks to get higher returns. Your diversification strategy here would be to actually invest in higher-risk investments such as equities, commodities and cryptocurrencies. You would allocate a smaller proportion of your investments to safe investments such as bonds or fixed deposits.

For investors who are older, risk-taking diminishes and the strategy for diversification will be different also. No longer will you rely on high-risk high returns investments, but rather your objective is to actually lower your risk and generate steady returns. The preference here will be to shift into safer investments while retaining a smaller proportion of risky investments.

Hence, diversification isn’t just a matter of reducing all risks but determining which type of diversification will suit your financial goals at different stages of your life.

Investor #3: If You Plan to DIY, Remember You Need at Least 20 Companies and Some Alternatives

For the investors who like to have control over how to diversify their investments, remember that you need at least the following asset classes to diversify:

  1. Safe investment as the base: Remember that you need a safe investment base (fixed deposits, government bonds) to establish a steady minimum return for your portfolio. This will effectively cap your losses should your riskier investments don’t pan out.
  2. At Least 20 Companies: A good barometer of how many stocks to buy is about 20 companies from different sectors of the market. This ensures that you have the necessary minimum exposure to the whole market.
  3. A Few Alternative Investments: You can combine a few alternative investments like cryptocurrencies and non-fungible tokens which have higher risks.

Of course, these are just general suggestions.

The pros of doing it yourself for diversification ensures that you have full control over what type of assets that you want to buy and possibly construct a diversified portfolio that is best for you at the current juncture of your financial journey. It also challenges you to do your own research and take responsibility for your own investing decisions. Both are essential characteristics to develop into a savvy investor.

Investor #4: Diversification Does Not Mean It’s Efficient

If there is one thing to understand about diversification, it does not guarantee that it will be efficient. Efficient here means that the portfolio that you have gives you the maximum returns for the lowest amount of risk you are taking. That’s right, higher risk doesn’t necessarily mean higher returns and vice versa.

Diversification gives you exposure to multiple asset classes and sectors, but the selection matters here. If you diversify your portfolio with companies that are underperforming or fundamentally bad, you will be taking on unnecessary risks for little to no returns. That isn’t diversification. That is making bad investment decisions.

Hence, you need to be careful about the assets that you are investing in for your diversification process. If you are electing for robo-advisors or fund managers, look for one that has solid financial performances. Diversification is not the end-all be-all investment objective. You still need to do your research in selecting the right kind of assets and financial products.

Entrepreneur #1: Diversify into Businesses That Have Synergy to Your Main Business

If you are an entrepreneur and thinking about how to diversify, most businesses and companies do it by investing and building businesses that are closely related to their main business. It is unwise to diversify by investing in a business that you don’t understand and unrelated to your main business.

While some companies do have businesses that are unrelated to each other, they are normally large companies that have high amounts of capital to take such risks. Diversification for an entrepreneur involves creating more income streams that reduce the risk of having just one. Perhaps what is more important is to actually generate viable income streams through your existing knowledge of your core business.

This way, you can even improve your existing businesses through the synergies from new investments and also ensure that you have a firm grasp on what to do.

Entrepreneur #2: Diversification Involves Taking Risk First Before Reducing It

The diversification process as an entrepreneur is very different from an investor. Firstly, as an entrepreneur, you diversify by investing and building more income streams for your company.

This means that you will probably have to take the risk of investing in businesses that you might not fully understand or build businesses that might fail. This is very different from the diversification process of an investor where you can just exit an investment if it is not going well. As an entrepreneur, you are probably stuck investing a lot of your money into businesses and waiting for 3 to 5 years for them to generate income.

Only after the business that you have invested in or build is successful, you can reduce your risk by having more reliable income streams. Before that, be prepared to take higher risks at the beginning.

Conclusion

Many people view diversification as the holy grail of investments in terms of minimizing risks and maximizing return. While this is true to some regard, the process of diversification is much different in real life for investors and entrepreneurs.

Firstly, as an investor, you don’t actually need a lot of money to diversify and you need to do so according to your risk and preferences. If you plan to do it yourself, remember that you need to invest in at least 20 companies and some alternative investments also. While diversification does reduce your risk, it doesn’t mean that it’s efficient.

For an entrepreneur, the process of diversification is much different as you would need to invest in businesses that have synergy to your core business. You would also need to take higher risks in the beginning before reducing them after you have successfully established more income streams.

 

Let us know in the comments below how your diversification process is like or what you intend to do about it.

 

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