Diversification strategies

The negative global economic effects brought by the Covid-19 pandemic have started to slowly recede as countries start recovering from the worst of the crisis. Even if most countries are not out of the woods as yet, 2022 is poised to be a year of recovery with Covid-19 vaccine access emerging as a critical determinant to recovery.

For the discerning investor, 2022 is the year of recovery. It is the year to take a vantage position and reap from your investments as the economy moves out of recession, recovers and stabilises.

To achieve your investment goals faster, you need to invest your savings in portfolios that yield above-market returns. This implies selecting the top growth financial assets, optimising risk exposure, and having the right discipline to keep reinvesting into the portfolio.

This works best if you are a young person who can invest savings for several years or decades and benefit from stock growth and reinvested dividends.

One of the ways you can reap as an investor is through a well-crafted diversification investment strategy. Diversification is defined as the technique that reduces risk by allocating investments across various financial instruments, industries, and other categories. It aims to maximise returns by investing in different areas that would each react differently to the same event. 

Why diversify? How and when should you diversify?

As an investor, one of the most important reasons for diversification is spreading one’s risk to maximise returns in assets classes similar to your risk tolerance. This means spreading your investment portfolio mix in line with your risk appetite but performing better than your current position.

Historically, investors who diversify their portfolios have had a better chance of ending up with higher returns because diversification reduces portfolio volatility and mitigates losses from any one security or asset class.

When deciding to diversify your investments, certain imperatives need to be considered, among them capital allocation, asset allocation, and security selection.

The first consideration is assessing your current holdings and portfolio mix.

Many clients have invested in asset classes that give them fixed income through unit trusts like the money market fund. Few individuals have a share and stock mix. A lesser number has exposure to REITs (Real Estate Investment Trusts).

Secondly, determine what percentage of your investment you want to expose to other asset classes according to your risk appetite. For example, in the stocks portfolio, you may choose to invest in the financial counters, which pay good dividends year on year. Hence you can peg a return from this in the top four performing banks listed at the USE/ NSE.

Another consideration is whether you are chasing capital gains or cash flow, or both. Capital gain is realised when you sell your investment. For example, you can buy a stock at Shs626.7 and sell it at Shs940. Your profit of Shs313 is the capital gain. You can buy a house at Shs30 billion and sell it at Shs62 billion and you have a capital gain of Shs30 billion.

Cash flow is when you buy a stock that pays a dividend every half year, and it can come from rental income and business income, among others. You buy and hold the investment to continue earning distribution income over time.

At most, pick a minimum of four asset classes to diversify into according to your age and risk profile. For example, you can benefit from investment in both shares and REITs. In shares, you buy a share at a certain price and hold for the long-term while still earning dividends and waiting for the price to go up then you can choose to sell or not.

In REITs, you buy the units at a price and earn dividends from the distribution done by the REITs manager. You can also sell the REITs when the unit price goes up if you wish.