The following risk management methods are commonly used in diversification:
Expansion of production, purchase of new equipment. Thanks to this, a stable position in the market is achieved.
Expansion of the product range.
Merger of firms with similar resources. Their names can also be combined. Joint activities provide advantages in the conditions of market struggle.
Absorption. The difference between this and the previous option is that here a small company is merged into a larger organization.
Accession. One line data package enterprise becomes legally dependent on another, but at the same time retains some independence.
Investing part of the finances. At least a share of savings must be used to generate profit. An additional source of income can mitigate the consequences of unforeseen factors.
Using derivatives (options, futures), which allows reducing individual risks. This method is recommended if raw material purchases are planned, but it is difficult to predict changes in exchange rates.
When implementing investment diversification, strategies consist of different ratios of assets included in the portfolio. In particular, the 60/40 strategy is widespread. This means that assets are distributed in the portfolio as follows:
60% – company shares,
40% – highly reliable bonds.
However, in recent years, this strategy has begun to justify itself worse. It becomes successful only during periods of global economic growth and stability in international relations. Uncontrolled price growth and global crises make such a portfolio untenable.
Methods of risk diversification
Increased profitability can be achieved by investing separately in shares of different companies. The final portfolio may look like this, for example:
oil and gas sector papers – 10-15%;
semiconductor sector – 10-15%;
retail – 10-15%;
gold and shares of companies mining precious metals – 10% each;
bonds – 10-20%, optional element;
telecommunications sector – 15%;
cryptocurrency – 0-10%;
real estate (through REIT) – 10-15%.
The above asset combinations yield impressive results. Over 16 years, the value of such a portfolio has increased almost fourfold, despite the past crises. Even in the late 2000s, in the context of a rapid decline in average market prices, its loss ratio did not exceed 20%. Research has confirmed the reliability of this scheme.
Effective instruments for diversifying financial risks are provided by exchange-traded funds and REITs. Here, ready-made portfolios act as shares; purchasing assets from 8-10 ETFs is enough to form a portfolio with broad diversification.
Correlation and risk diversification
Correlation is used to assess the interdependence of the dynamics of two assets. If the correlation approaches one, the assets change in approximately the same way. On the contrary, if the correlation reaches -1, the changes occur in different directions.
A good investment portfolio should contain assets with weak correlation.
Selecting investment instruments based on statistical data is not an easy task. In addition, the indicators of previous periods do not say anything about further development. However, there are basic principles that allow you to reduce the likelihood of a sharp decline in your portfolio and get the greatest effect from diversification:
To build a diversified portfolio, buy ETFs. Each fund includes shares of a large number of companies from different sectors and regions. Bond ETFs allow you to buy a set of bonds at once. Through the gold ETF (FXGD), it is very easy to invest in precious metals.
Diversification by country is also important. No matter how attractive a market is to you, do not focus on it. It is best to combine developed and developing markets in a portfolio. There are constructors for determining the ratio of different countries, and investing in global funds FXWO/FXRW can also help.
Make sure that the value of assets is set in different currencies. In this case, currency diversification is maintained and the influence of external factors that lead to strong fluctuations in exchange rates is neutralized.
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