Whether you are working or retired, you should get the maximum return on your investments.
A good way to do this is to diversify your investments. You will increase your portfolio return potential while protecting yourself from market fluctuations.
Diversification is the golden rule of investment; even the top-ranked portfolio and pension fund managers always diversify, which largely explains their success. What exactly is diversification? It simply means: don't put all your eggs in one basket! Furthermore, all financial advisors agree on basic triple diversification.
If, for example, you invest $20,000 in an international equity fund, your portfolio then becomes vulnerable to foreign market fluctuations. If however, you distribute the same amount among several types of investments (term savings, bonds, dividend funds, Canadian and foreign equity funds), you will increase your chances of obtaining a good overall return, regardless of market conditions.
It is important to understand that the major categories of investment (liquidities, bonds, equity) do not fluctuate in the same way, or at the same rate. When interest rates change, some investments may rise while others may register a drop. This is why it is wise to diversify: you will always benefit from economic fluctuations.
- Investment diversification means that your portfolio includes liquidity, fixed-income securities (such as term savings or bonds) and growth stock (equity or equity fund shares). Thus, you benefit from complementary investments that differ in their return characteristics and performance.
- Term diversification is useful in the short, medium and long-term. If you have $10,000 to invest in term savings, you can spread this amount in equal parts over 5 years: $2,000 in a security for a 1 year term, $2,000 in a security for a 2 year term and so on. This way, you will receive income annually from your maturing investments, which you can reinvest for the long-term to benefit from increasing rates.
- Geographical diversification is including Canadian and foreign securities in your portfolio and benefiting from economic growth, regardless of the continent or country of origin.
You can diversify to a greater degree than basic triple diversification:
- Diversification of economic sectors of activity: These sectors do not react in the same way as market trends; if you invest in shares, it is important to distribute your assets among various sectors of activity (such as health care, technology and public services). You may invest in Canadian or American equity funds. If so, their portfolio mix generally already includes diversified sectors.
- Diversification of capitalization: When you invest on the stock market, regardless of whether you invest directly or in mutual funds, it would be wise to choose growth company securities (small and medium capitalization) over major company securities (large capitalization) because, in any given economic situation, they do not always behave in the same way.
- Diversification of management styles: Diversify your mutual funds! Choose funds where different managers have different management styles. Some may be aggressive, others may be more cautious. These styles complement one another and increase your return potential.