Through ordinary real-life experiences that are unrelated to the stock market, we can learn a few things about diversification. For example, you may have noticed that street vendors often sell seemingly unrelated products e.g. umbrellas and sun hats. At first glance, it may seem odd that someone would buy both items at the same time. Street vendors know that when it’s raining, it’s easier to sell umbrellas but harder to sell sun hats. However, when it’s sunny, the reverse is true. By selling both items – i.e., by diversifying their product line – the vendor can reduce the risk of losing money on any given day. These are the building blocks to understanding asset allocation and diversification.
Asset allocation involves dividing your investment portfolio among different asset class, such as stocks, bonds, and money market instruments. The process of determining which mix of assets to hold in a portfolio at any given time will depend largely on your time horizon and risk tolerance.
Diversification on the other hand is a risk management strategy. It can also be explained by the adage “Don’t put all your eggs in one basket.” The strategy involves investing money among various investments in the view that if one investment underperforms, the other investments will more than likely make up for those losses. Many investors use asset allocation as a way to diversify their investments among asset classes. Choosing an asset allocation model won’t necessarily diversify your portfolio (e.g. investing 70% of your portfolio in one stock and the balance of 30% in one bond). What will ensure your portfolio is diversified will depend on how you spread the money in your portfolio among different types of investments. A diversified portfolio should be diversified at two levels: between asset classes and within asset classes.
Investment diversification is one of the great advantages of mutual funds. The investment diversification of mutual funds mean that an investor can obtain instant access to a wide variety of individual stocks or bonds with a low minimum investment.
Mutual funds are investment vehicles that are made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar asset. Mutual funds are operated by qualified Fund Managers who are responsible for investing on behalf of investors in order to provide capital gains and income. At FBN Capital Asset Management, we manage mutual funds across a number of different asset classes.