While financial management is something that needs constant monitoring and all investment carry a degree of risk, a number of strategies can be employed to minimise this.
Diversification is one way of minimising risk, with investors incorporating investment from different “asset classes” in their portfolio.
Asset classes refer to groups of investments that hold similar traits and often act comparably in the market.
What is diversification?
Diversification is the allocation of funds across different investments to maximise returns and hedge risk.
Individuals with “discretionary income” – money remaining after paying for necessities that can be used for investing, saving or spending – could put some into real estate, for example, and some into well-regulated investment products such as stocks.
When investing in stocks, investors should not invest all their money in a single stock, but rather in companies from different sectors or with different market capitalisation as this brings different degrees of risk and profit.
When two stock issuers are both in the same or even similar sectors – or that have a positive correlation, with one moving in tandem with the other – the stock prices of both entities tend to move in the same direction, rising or falling at the same time.
“Don’t put all your eggs in one basket” goes the old saying, and to minimise risk and offset losses should one investment fail, an investor can diversify by investing in stocks of companies in different sectors and that have a negative correlation.
Should a business fail or one sector perform badly, any losses should be offset by the uncorrelated investments held.
For example, with Phnom Penh Autonomous Port and Sihanoukville Autonomous Port being both in the same sector, their share prices will usually fluctuate in parallel.
In contrast, as Phnom Penh Autonomous Port and ACLEDA Bank Plc, for example, are in two separate sectors, an investor in this case is able to benefit from their low correlation.
A low correlation decreases volatility, with investments increasing and decreasing at different rates and times, and for different reasons.
A portfolio with diversified investments can perform better and bring more consistency.
The benefits
• Maximise return and hedge risk against market fluctuations;
• Explore the benefits of a number of investment tools;
• Achieve long-term investment plans;
• Keep capital safe.
Before buying stock, investors should analyse the company based on the quality of its business model, market demand, potential products and reputation, as well as the market price, liquidity and regular annual dividend distribution, and dividend payment growth.
However, as analysing each company before investing is time consuming and can be confusing, investors should not invest in too many stocks at once, while a portfolio can become over-diversified if including a company leads to the expected return being reduced more than the risk.
Reference: https://www.investopedia.com/investing/diversify-your-portfolio-beyond-stocks/
Prepared by: Securities and Exchange Regulator of Cambodia, Department of Research, Training, Securities Market Development and International Relations.
Email: [email protected].
Phone: 023 885611.
