Diversification is the best way to reduce risk

PUBLISHED : Sunday, 22 April, 2012, 12:00am
UPDATED : Sunday, 22 April, 2012, 12:00am


The last financial crisis showed that most investors need to diversify their investment portfolios. Diversification reduces your risk through investing in a variety of assets ranging among equities, commodities, metal, bonds, real estate and others.

If the prices of these assets don't move together, along with the market, it will create less risk for your entire portfolio. By averaging your holdings, the diversified portfolio's overall return should be greater than your lowest performing investment.

Today there are many investment vehicles that allow you to achieve the level of diversification that is suitable for your financial and lifestyle goals at a low cost.

Various index or mutual funds and ETFs (exchange traded funds) execute numerous strategies intended to diversify risk.

Despite the fast growth in the China market, local private investors can allow their portfolios to become too concentrated in mainland-listed A shares. Long-term investment planning rather than market time or trading should drive diversification and wealth planning.

Your portfolio should be checked and rebalanced every year to ensure that it is diversified enough to meet your goals. Investors need to work with their independent advisers or investment bankers on asset allocation. According to Jean Claude Humair, regional market manager for UBS: 'Clients need to know that asset allocation [between fixed income and equities] drives 90 per cent of long-term returns.

'Asset allocation should be reviewed every year. For example, portfolios should reflect the fact that in 2009 equities outperformed bonds and in 2010 fixed income outperformed equities.'

One advantage of being a client of a private bank is that you can outsource the task of diversification, especially the job of finding the right mix and type of securities and funds needed to achieve this.

While your stockbroker can offer you short-term trading advice, you may require a private bank or independent financial adviser to help you establish and maintain a long-term, diversified portfolio.

Investor knowledge has changed and improved since the financial crisis. Asian investors better understand how diversification can reduce volatility and raise returns.

Lok Yim, Deutsche Bank's head of private wealth management for North Asia, said: 'They also understand that volatility is the new norm - it's here to stay. So risk-adjusted rather than nominal returns are an important criteria. Trading now comprises a smaller part of a portfolio.'

While many Asian investors are still building wealth, preserving it is now recognised as an equally important priority.