In part 4 of our educational series, we’re learning about diversified portfolios and how it can help you become a more confident investor.
The basics, in 60 seconds.
Never put all your eggs in one basket. This is especially true when it comes to investing and you’re not looking to actively pick stocks. If you prefer investing your money passively and watch it move along with the market, listen up.
Let’s recall that the values of bonds, equities and cash can react differently to changes in the economy. By building a diversified portfolio, you are spreading your risks across different investments to lessen your exposure to under-performing assets.
Diversify. In stocks and bonds, as in much else, there is safety in numbers.
- Sir John Templeton -
By investing in different assets whose values can fluctuate in varying directions, you’re not putting all your eggs in one basket.
A practical example:
When equities are under-performing because the economy is doing poorly, you’ll be pleased to see that your losses are offset against bonds and cash. Even diversified portfolios can lose money so it’s important to select a portfolio that suits your risk appetite. If you want to achieve superior returns when the stock market is doing well, but ready to stomach larger losses if it is doing poorly, you should invest in a diversified portfolio with a higher proportion of equities and lesser amounts of bonds and cash.
Here’s a rule of thumb:
Whilst cash equivalents are relatively benign, the prices of bonds and stocks move in the opposite directions. When stocks go up in value, bonds go down. When the economy is doing well, and people are spending their money to buy goods and services, this trickles down to superior earnings and rising stock prices. When the economy is slowing down, companies experience lesser demand and lower earnings, making stocks less attractive. As a result, investors prefer the safer interest payments guaranteed by bonds. When building a diversified portfolio, you want a mix of cash, bonds and stock to lower your exposure to underperforming assets.
This explainer article is part of our ongoing education series to inform and educate the next generation of investors by explaining key investment topics. To learn more about Fountain, check us out online.