Why Is Diversification The Only Free Lunch In The World?

There is a good reason why diversification is regarded as the “only free lunch in the world”. It is one of the most effective risk management techniques available to investors, and applying it to your own portfolio is as easy as holding both stocks and bonds. 

Essentially, diversification is not putting all your eggs in one basket. The concept is simple. If your portfolio contained just one stock, your portfolio value is entirely dependent on the performance of that one stock. But if you invest in many different stocks, you’re reducing the risk of any one of them delivering disappointing returns. 

What is a diversified portfolio?

Simply put, a diversified portfolio is made up of assets that have no or low correlation. For instance, stocks and bonds are known to have a low correlation. When stock prices go up, bond values tend to go down. This is why the most basic form of diversification is to simply have a mix of both stocks and bonds in your portfolio.

Ultimately, a well-diversified portfolio is one that has a meaningful allocation to multiple asset classes, sectors and geographies. So beyond stocks and bonds, you can also consider adding real estate or commodities to your portfolio. 

How can you diversify your portfolio? 

Some investors think that owning 50 or even 100 different stocks gives them a well-diversified portfolio. That’s not necessarily true. If you invest in 50 stocks but they are all from the same country and sector, you’re not truly diversified because they are likely to be highly correlated.

One easy way to avoid this is by investing in different sectors and geographies. For stocks, this could mean investing in large cap, mid cap and small cap stocks. You could also own stocks from diverse sectors such as healthcare, energy, consumer goods and more.

Rather than just investing in the Singapore market, consider investing internationally as well. Different markets tend to have their own economic cycles. What’s more, larger markets like the US will offer greater exposure to successful global companies like Amazon and Apple.

Gain instant diversification with ETFs

Although the benefits of diversification are well-established, many investors hold just a handful of stocks because building a portfolio with dozens of stocks is expensive. The brokerage charges for each purchase or sale can quickly add up. 

But with exchange traded funds (ETFs), owning a big basket of stocks has never been easier or more affordable. ETFs allow you to invest in a basket of stocks with just one transaction. For example, if you buy the SDPR S&P 500 ETF, you are effectively investing in 500 top US companies.

You can invest in ETFs through a broker or via a digital wealth advisor like Syfe. First, there are no investment minimums so you may choose to invest a lump sum or dollar cost average depending on your preference. Moreover, there are no brokerage fees or transaction costs. This lowers your investment costs even further, which leaves you with higher returns. 

You can choose the Syfe Core or Core Equity100 portfolios if you want to invest in ETFs. Ready to start your ETF investing journey? Learn more about Syfe’s ETF portfolios here.