You may have definitely come across the idiom, “Do not put all your eggs in one basket” at some stage in your life. In sophisticated business terminology, this means money diversification and the concept is a fairly important one, especially in asset allocation. Having a solid economical foundation heavily relies upon the diversification of your money savings and investments. Is diversification really crucial and more importantly, should you diversify your savings? Read on to find out more.
Why is diversification of savings important Imagine a hypothetical scenario in which you have a solitary portfolio of bus network stocks and for some reason, the prices of the stocks drop significantly. You will then suffer a huge setback. But if you were intelligent enough to diversify your savings in other stocks in the transportation industry, let’s say in freight train stocks, only a portion of your investment portfolio would have been affected.
Counterbalancing your stocks with other areas within the same class will help you minimise the losses but only to a certain extent because the industry is the same and both may share a greater degree of correlation than you may contemplate.
This is why you should consider diversifying your savings in multiple classes of assets. In this way, you will not just be implementing diversification with respect to different types of companies but also different trade and commerce types. The lesser the correlation between your money saving investment schemes, the better it is for your financial portfolio. So the major benefits are:
Reduces the Risk
Diversifying savings simply means that you invest in different classes of asset. This is done to reduce the impact of risks that may occur to your portfolio from the financial losses of a single asset.
Protects From Market Swings
The financial market is extremely volatile in nature and the value of your assets fluctuates sporadically. If you diversify your savings in various asset classes, you will make your portfolio less susceptible to any such swings in the market.
An important thing to keep in mind over here is the ambivalent nature of the financial market. This means that there is no guarantee that diversifying your savings would make you immune from the transgressions of the fluctuating market. However, it will accomplish the essential purpose of minimising the financial losses greatly.
Types of Asset Classes
The various asset classes may be broken down into the following categories:
- Shares and equities which basically means that you have a stake in a company.
- Fixed interest securities—this type of saving is called bonds and it essentially means that you have given a loan to a company at fixed interest rates.
- Property Investments in buy to let properties, commercial and residential investments in real estate companies and funds.
- Cash such as savings accounts like the Help to Buy ISA and Lifetime ISA.
- Other investments in precious metals, exquisite wines, and all other types of savings that do not fall into the aforementioned categories.