There are plenty of areas within your portfolio in which you can diversify; i.e asset class or currency but why is it so important? Well, I’m an economist by profession and I read somewhere that there are two types of economists. Those who know the future, and those who don’t know they don’t know the future! It is precisely because of the uncertainty of life and the uncertainty of the financial markets which affect our financial portfolios that we MUST diversify.
Let’s take property as an example. Property is probably the most beloved asset class to invest in. One of the reasons for this is probably because of how tangible it is. You can see, feel and touch it and so that gives you a sense of security. Using that famous saying, if you put all your eggs in property, for example, you leave yourself severely exposed.
Just a few years ago, owning commercial property in Zambia was something of a no brainer, whether for individual investors who had the capacity, or for corporate investors. Again, you don’t have to be a real estate guru, but you just have to look at the ever changing Lusaka skylines due to all the new office buildings being constructed to notice that the supply of commercial property is going up.
A simple yet fundamental truth of economics is the law of supply and demand, and when the supply goes up the price goes down. This can be particularly damaging on any medium to long term planning because you may find yourself in a position where the return you get on your investment goes down, and even finding a tenant becomes increasingly more difficult. Properties are also notoriously illiquid. A mentor of mine often told the story in order to drive the point home, that you can’t take a brick out of your house and take it to the bank in exchange for cash. This means you don’t want to count on your property for any emergencies that may arise where you quickly need to liquidate your position.
Does this mean you shouldn’t have property in your portfolio? Not at all! Property is arguably the most important piece of your long term financial portfolio. The trick is finding a balance but the question is a balance between what? One of the ways you can diversify is through …property! Again, depending on one’s capacity, owning property outside of the country immediately diversifies your position as that property will not be exposed to the same economic climate as your local property and could serve as a buffer.
Another way to diversify is through investing in different asset classes. While property can generally be considered a conservative investment, equity, or shares are generally considered more risky, however they are a lot more liquid (something our own stock market sometimes struggles with unfortunately) than property. The nature of equities, which can be quite volatile mean that in order to maximise on the benefits of them for your portfolio, mean that you have to hold them over a long period of time in order to mitigate the risk and averaging out the cost. (I dealt with the benefits of cost averaging in another article).
Using the example of two asset classes (for simplicity’s sake) we have seen how a mix between assets can shield you against future uncertainties. Of course everyone has their own preferences and their own goals and objectives and it is important to make sure that your mix of assets or….eggs in your basket fits your circumstances.