I’m not a risk taker. I’ve never really been the type of person to take unnecessary risk. I like having options and for me putting all my eggs in one basket limits my options. In fact, I would consider myself a conservative investor with respect to financial risk tolerance.
But here’s the weird thing. My investment portfolio is 75% equities and 25% fixed income. With respect to investing; that’s not what you would consider a conservative portfolio for someone who claims to have a low-risk investing threshold. So, how is it I can claim to be a conservative investor and yet have a high-risk investment portfolio? One word; diversification.
I’ve written previously about risk and how for the most part we tend to have a dated view on how we define risk. For the most part, we either see risk as a means to achieve something we want or view risk as something that should be avoided to keep what we already have. I don’t view risk in the same context. I have a high-risk portfolio because I believe it’s not as risky with the help of diversification. But before I continue, let’s look at diversification more closely.
When speaking about diversification in the investing context, I am talking about a way to reduce the risk exposure or spread the risk exposure with a portfolio. Investing isn’t a for sure thing. Stocks you believe will do well sometimes go bankrupt and others you believe would go bankrupt end up doubling their value. The idea behind diversification is you’re likely to be wrong more times than you would like to admit and as such you want to avoid trying to constantly pick the winners. Therefore, you pick a little bit of everything in and effort to reduce your risk exposure.
Let’s use my portfolio makeup as an example. I have 75% of my money invested in equities and the other 25% in fixed income. If you’re thinking 75% of my money in equities is risky, you would be right.
Here’s how I reduce that risk, though. I’ve diversified within my equity holdings. I didn’t simply investment my entire money in a couple of stocks I thought would do good. I hold over 500 companies in different sectors, countries, industries, that are large and small. I reside in Canada but I’m fully aware most of the goods I consume are not from Canada. For example, the iPhone is made by an American company. As such, of the 75% of my money that’s invested in equities; I have 25% in US equities, 25% in Canadian equities, and 25% international equities.
Within each of those regions, I have stocks in large companies such as Apple as well as in small companies. And when it comes to my fixed income portion of my portfolio; I have the 25% spread across federal, provincial, and municipal bonds. Also, the bonds have different time from 90 days all the way up to 30 years.
That’s the great thing about diversification. If you’re probably diversified and avoid trying to constantly pick the winners; your chance of success is much greater. Diversification is a critical piece to investing in reducing the portfolio’s risk profile. And for me, at least, when I look at how I can reduce the potential risk by spreading it around I feel comfortable having a 75/25 portfolio mix. I’m not advocating that everyone needs to do that but rather stressing the importances of diversification to reducing risk within a portfolio.