Why diversify?
One of the most important lessons I learned when I began investing is the importance of diversification.
Diversification is important because various asset classes perform differently. For example, last year, local bonds performed better than stocks. However, there were other times in the past when stocks performed better than bonds.
Owning a bit of both will allow your portfolio to be less volatile and perform more consistently over time compared to a portfolio that just focuses on one asset class.
Even among the many stocks listed on the Philippine Stock Exchange (PSE), their performances vary. For example, among the PSE index (PSEi) members, Converge was the best-performing stock in 2024 as its share price almost doubled. On the other hand, Bloomberry was the worst-performing stock as its share price fell by 53.5 percent during the same period.
If you were unlucky enough to have Bloomberry, your portfolio would not have performed as badly if you also owned other stocks.
Another reason why diversification is important is to avoid mistakes that would lead to huge losses.
When it comes to investing, the amount of capital you have is very important in determining the absolute returns you can generate. For example, a 20-percent return on a P100,000 portfolio is only P20,000 while a 10-percent return on a P1-million portfolio is P100,000.
If you already have P1 million, you don’t want to make any mistakes that would lead to a significant reduction in your capital.
One way to do this is by avoiding concentrated bets on any stock as unforeseen circumstances could cause a company’s share price to go down sharply, leading to significant losses.
That said, there are many ways to diversify aside from buying more than one asset class and more than one stock or bond.
One way is to buy foreign stocks and bonds. Foreign stocks and bonds perform differently compared to Philippine stocks and bonds, especially those belonging to countries outside Asia.
Last year, the US’ S&P 500 rose by 23.3 percent while the PSEi increased by only 1.2 percent. For the year-to-date period, both the S&P 500 and PSEi are down. However, there are other markets, such as the Chinese market, that are performing well.
The good news is funds that are focused on investing in foreign stocks and bonds are now available to Filipinos who would like to gain exposure to overseas markets. These funds can easily be bought through asset management companies, banks and brokers, and for only a few thousand pesos.
Another way to diversify is by buying stocks and bonds that belong to different sectors. This, as unique factors affecting different industries explain their divergent performances.
For example, last year, the PSE financials index went up by 24.1 percent as banks enjoyed higher margins and steady demand for loans. On the other hand, the PSE property index went down by 16.7 percent as sentiment for property companies was negatively affected by high interest rates and the prevailing oversupply of residential condominiums and office properties for lease.
Finally, when buying bonds, you can diversify by buying bonds with different maturities—some long, some short. That way, your bonds mature at different times, improving your liquidity and your ability to capitalize on opportunities as they become available.
For example, if you invested all your funds on a 10-year bond during the height of the COVID-19 pandemic when interest rates were very low, you would not be able to invest in bonds that provide much higher yields right now.
Diversification is an important risk management tool as it helps you reduce volatility and avoid huge losses. Although your potential return might not be as high as someone who makes a concentrated bet on a stock that more than doubles in a year, at least you can sleep well at night knowing that you don’t have to worry about the risk of losing most of your investment because of one wrong move.
