Three reasons why you should diversify your portfolio
Simply put, diversification is not having all your eggs in one basket. In other words, spreading your investments across different shares, sectors and assets. This is because investing is risky. And by employing some diversification, you can offset some of this risk you take on. Let's take a closer look at why you should diversify your portfolio…
The risks you take on when you invest
Let’s say you buy shares in Pick n Pay. What risks are you taking on?
1. Company risk
When you buy a particular share, you take on company risk, Matthew Partridge in Money Week explains. For instance, if the company hits some issues, the share price will likely fall.
2. Sector risk
When you buy a share in a particular industry or sector, you take on that risk. So in our example, you take on any risk associated with the supermarket sector. For example, if the supermarket sector starts to fall out of favour due to an increase in online shopping, your shares could suffer.
3. Market risk
This is a step even further back. This looks at the market as a whole. And if investors start to turn their backs on South African stocks, your shares could suffer.
The role that diversification plays
If you diversify
your portfolio, you could reduce the effect of these three risks.
Going back to our example, if you invested in more than one supermarket company, you’d offset company risk.
If you invested in companies from other sectors, you’d reduce your sector risk.
And you could reduce the effect of market risk by investing in different asset classes, like bonds and property. And also by investing in a different market, such as investing offshore.
So there you have it, three reasons why you should diversify your portfolio.