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Allow Your Investments To Divide And Conquer

Allow Your Investments To Divide And Conquer

Diversification is key to earning better rewards and balancing market fluctuations.

Don’t put your eggs in one basket, goes the old saying. If the basket slips, your prized possessions will tumble towards a messy, yolky end. Never has this been truer than when investing for your future.

Solid investment strategies include diversification. Essentially, this means introducing variety, and making sure that you’ve put your hard-earned savings into more than one economic sector.

David Denton-Cardew, deputy head of Middle East Proposition at Zurich International Life says: “People often ask me which market I think will perform best over the coming months, but rather than focusing on the next ‘hot’ investment area, investors should diversify across asset classes and geographic regions, as this will reduce their portfolio risk and enhance their long-term potential for investment return.”

There are three strong reasons why diversification is essential for sound investments. The first deals with buffering against market fluctuations.

Let’s assume that you’ve been saving a while and have decided to invest in real estate – say a holiday home in Lisbon. The idea is that this asset will generate rental income from holidaymakers or tenants. Not only will you get the rent proceeds but you should also benefit from the market value of the asset if you should decide to sell it in the future.

So far so good. But let’s now assume you’ve now made some more money, and so you decide to buy a second holiday home, also in Lisbon. While this might appear to be sound – after all, you say, the first property is working out well. Not so. The concern here is that any extraneous factor that affects the price and performance of your first house will also hit the second. A volcanic ash cloud or terrorist threats could reduce tourist traffic, making it harder to rent your property out. A job market slump could mean your local tenants approach you to negotiate lower rents. House prices could plummet due to market movements. So, not only would you not be able to rent out your house at preferred rates but selling it in the middle of a downturn means you would lose out on possible returns.

The second driver of market diversification comes from the relationship between reward and risk. In global markets, the riskier the investment, the bigger the potential for reward. One of the safest investments is to put your money in a bank. The only trouble is that the investment’s risk-free nature means your returns are going to be minimal. In fact, bank interest rates are usually calibrated to only cover the effects of inflation, and sometimes not even that. For instance $5 stuck in a savings account in 1987 would give only give you the equivalent in terms of spending power come 2017. It won’t make you better off in real terms because the $30 you have in 2017 will only buy what $5 did back in 1987.

In order to grow your portfolio of investments, you will want to mix them up to centre a balanced portfolio. Depending on how risk averse you are, you’ll want to categorise your portfolio into safe investments that generate smaller returns and riskier investments that offer higher yields. For instance, safe government bonds can supplement fixed deposit accounts. A percentage of your portfolio can be directed towards more volatile investments such as stocks and futures.

The third driver of diversification is the need for liquidity. Most people invest to have money for future costs – such as college funds for the kids. If all your money is locked up in immobile assets such as real estate, you might find it difficult to liquidate at the right time. Market conditions might not be right. Turning your asset into cash might take time, and there might be overheads and hidden costs. It’s a good idea to diversify your portfolio to include some assets that can be liquidated easily – such as fixed deposits – so you can access ready money if you should need to.

But beware of false diversification: sticking your eggs in a couple of baskets that at first glance might appear unrelated, but are actually affected by the same market forces.

Say, for instance, that you’ve bought an apartment in Dubai. You might decide for your next investment to buy into a supermarket in Jebel Ali. Real estate and retail have no link, right? Wrong. If a slump were to hit the real estate market, you’d lose rental returns and the price of your base asset would depreciate. That much is obvious. But your supermarket might not be safe either. Jebel Ali is where most of the labour camps are, and chances are that construction workers make up most of your clientele. A real estate slump might mean a halt in construction activity, which in turn would result in an exodus of manpower. Your supermarket would lose its customers, and you’d lose revenue. This isn’t a made-up example. Such hidden correlations came to stark light in the economic crash of 2008, where a host of ancillary businesses were affected by a fall in real estate activity.

Diversify. But above all, don’t panic. Most sound investments appreciate in the long-term. Your stocks and real estate will almost invariably be worth a lot more in 20 years – as long as you have the patience to stick it out. Inflationary and recessionary market cycles have a five-year duration, but a sound investment will be around a lot longer.

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