By Lynette Tan
If you’ve only got a minute:
- Spreading investments across various asset categories, both broadly and within each category, is a common diversification method.
- Alternative diversification methods include focusing on specific investment factors, investing in themes, and employing a dollar-cost averaging strategy.
- Although diversification is essential, excessive diversification can reduce potential gains and complicate performance monitoring.
A cornerstone of sound investing, diversification is a crucial risk management technique. It involves strategically allocating capital across a range of assets, mitigating the danger of concentrating investments in a single area.
Diversification provides a buffer against market volatility. When certain holdings decline, others may be performing well, thereby stabilising overall portfolio returns and preventing significant losses.
We'll explore 4 distinct diversification approaches: balancing traditional assets like stocks and bonds, focusing on specific factors that drive returns, investing in emerging themes, and implementing strategies that account for market cycles over time.
Here’s how you can build a diversified portfolio that’s tailored to your goals — and more importantly, one that works in real life.
Foundations of diversification
- Diversification across asset class
The first step is to split your investments among different types of assets with varying risk-return profiles.
Equities (Stocks): These offer growth potential but come with higher volatility.
Bonds: More stable, with regular income. Good for cushioning your portfolio.
Cash & Equivalents: Think savings accounts, T-bills, or money market funds. They offer liquidity and safety.
Alternatives: Real estate (including REITs), gold, or even crypto (for the adventurous). These can hedge against inflation and market downturns.
A traditional approach to diversify across asset class might look like having a portfolio of 60% to equities and 40% to bonds, for example.
- Diversification within asset class
Even within the same asset type, you can diversify to spread your risks.
Equities:
- Geography: Don't only invest in Singapore (e.g. STI ETFs). Add exposure to the US, China, and emerging markets.
- Sectors: Tech, healthcare, finance, consumer staples — each behaves differently depending on the economy and market cycle.
- Market Cap: Mix of large-cap (e.g. Apple), mid-cap, and small-cap companies.
Bonds:
- Blend government bonds (e.g., Singapore Savings Bonds, SGS) with corporate bonds or global bond funds.
- Consider different durations (short-, medium-, and long-term) to manage interest rate risk.
4 Diversification approaches
Constructing a well-diversified portfolio isn't just about selecting a variety of assets; it requires a strategic blend of investment strategies.
1. Traditional core portfolio
A diversified portfolio often begins with core holdings in low-cost, broad-market ETFs or unit trusts. These funds typically track indexes like the S&P 500, the STI, or global bond indexes, offering foundational stability, simple management, and wide-ranging diversification for your investment strategy.
2. Factor-based investing
Enhance your diversification strategy by incorporating factor-based investing. These factors, including value (undervalued stocks), momentum (stocks on a winning streak), and quality (companies with strong fundamentals), have historically delivered excess returns over the long term.
3. Thematic or Satellite investing
Allocating a smaller portion of your portfolio (5-15%) to themes like Artificial Intelligence, Renewable Energy, Healthcare Innovation, or ESG (Environmental, Social, Governance) can boost returns and align your investments with your values. However, remember that these thematic investments can be more volatile, so a smaller allocation is recommended to manage risk.
4. Diversify over time
Timing the market is notoriously difficult and often counterproductive. Instead, focus on consistent investing over time through dollar-cost averaging (DCA). This strategy involves investing a fixed amount regularly (e.g., monthly), regardless of market fluctuations. DCA smooths out the impact of market volatility and instils investment discipline. Robo-advisory portfolios like DBS digiPortfolio can automate your DCA strategy, making it even easier to implement.
Review and rebalance regularly
Markets are dynamic, and your portfolio's allocation will drift over time. Establish a regular review schedule (e.g., every 6 months) to assess your portfolio's performance and alignment with your goals and risk appetite. Rebalancing involves selling some outperformers and reinvesting in underperformers to maintain your target asset allocation. This disciplined approach ensures your portfolio stays aligned with your long-term objectives and risk tolerance, maximising your chances of investment success.
Mistakes to avoid
While diversification is crucial, it's possible to overdo it. Over-diversifying by investing in too many funds or stocks can dilute potential returns and make it harder to track performance.
Another common pitfall is chasing past performance, loading up on investments that have recently done well, which is no guarantee of future success. Furthermore, neglecting costs like fund fees or hidden charges can significantly erode returns over time.
Avoiding these common mistakes can significantly enhance the effectiveness of your diversification strategy.
Diversification is not a one-time task — it’s an ongoing process of building, refining, and staying disciplined. Whether you prefer a simple ETF portfolio or want to ride the next big trend, what matters is that you invest consistently and intentionally.
