There are many different forms of diversification. Here are four different ways in which we can protect ourselves by diversifying our investments.
1. Risk diversification
The advantages of having our assets in both conservative and aggressive investment categories is that when the aggressive money is performing poorly, at least we know our conservative money is still producing. And when the aggressive money turns around, we can reap the rewards.
2. Time diversification
Time diversification deals with the time horizon associated with different investment vehicles. Short-term investment products (e.g. savings account and FDs under one year) offer security and liquidity. The trade-off is the low rate of return. But everybody needs to have some money in short term vehicles in case of emergency or as a liquid fund to take advantage of opportunities. The recommended guideline is three months’ salary.
For example, if you earn RM5k per month, you should have at least RM15k in short-term investments or liquid funds. (RM5k x 3 = RM15k)
Many people use an overdraft as a fallback. This way they avoid having large amounts of cash in a low-yielding investment vehicle. A balanced portfolio of equities or stocks should be held for the long-term since the best rates of return are achieved in long term investment.
3. Institutional diversification
Most people spread their investments between different banks, life insurance companies, and brokerage firms. Within reason, this is a wise move, as we don’t want to be in the position where every ringgit or our money is in one bank, insurance company, or brokerage firm. In requires more effort, but the added protection is worth it.
4. Management diversification
If you are looking to professional money managers such as brokerage or unit trust companies to manage your money for you, it makes sense to put your money in more than one company or fund. If one group reads the market wrong, you will not have lost all of your money with it.
The danger of over-diversification
Any time you can spread your investment, it is advisable to do so, but there is a limit. It is possible to over-diversify and have your money in too many places. There was a man (who shall remain nameless) who had 20 different unit trusts, all with investments under RM2,000, HE also had FDs at 13 different institutions. The flood of statements he received made it virtually impossible to stay on top of everything. But as with all retirement planning, each individual has to find a balance that is suited to his or her situation.
