What does preparing a gourmet sandwich and portfolio diversification have in common?

By Jx Tan, 22 February 2018 945

Like many Singaporeans, I am a fan of gourmet sandwich bars which provide a wide variety of tasty offerings of fresh bread, vegetables, meat and sauces. These sandwiches deliver a delicious and unique combination of textures, flavours and crunch.

Though gourmet sandwiches are becoming more popular, my family has never prepared this at home. I suppose most readers don't prepare these sandwiches by themselves as well. It is too much of a bother to buy small quantities of ingredients, such as thinly sliced carrots, alfalfa, onions, tomatoes, salmon and roasted turkey breast. Just look at the diverse amount of ingredients (I counted over twenty types of vegetables in the picture below), packed into a gourmet sandwich bar! Instead, I would rather leave it to the professionals at the sandwich bars.

When it comes to investing, the same mindset applies. When you invest on your own, it may be troublesome and costly to buy many different asset classes to form your own investment portfolio. This may mean that your investments are concentrated in just one or two market sectors or asset classes, putting your investments at a higher risk if that market sector or asset class under-performs. Instead, you can leave it to the fund managers (the professionals) and invest in a fund that is made up of different asset classes (ingredients) that suits your investment budget. This way, you can also attain a certain level of portfolio diversification. 
 

Introducing Portfolio Diversification

Portfolio diversification is an investment strategy to help reduce risk by combining different asset classes.  Think of it like having a sandwich with a number of different ingredients.

Diversification isn't a risk-free investment strategy. However, it helps to reduce overall risk in your investment portfolio by investing in multiple asset classes whose returns are not closely correlated to one other. In short, it helps to ensure that not all your eggs are in one basket. Now let me explain how you may put this strategy into action with these two steps:
 
  • Spread the risk and invest across asset classes

Don't put all of your investment in one stock, one sector or asset class.  Ideally, you should include different asset classes whose returns are not strongly correlated with one another, such as bonds and equities. This will help to provide different investment exposure. For instance, your overall risk exposure may be more balanced when you include equities which tend to be of higher risk, and bonds which tend to be of moderate risk.  You can also add gold in your portfolio to hedge against uncertainty and inflation or hold some cash for liquidity.  

The proportion of equity, fixed income instruments e.g. bonds, and cash will depend on how much risk you can stomach and how long you intend to invest.
 
  • Reviewing investments and averaging over time

As stated earlier, portfolio diversification doesn't mean your investments are risk-free. Stay current with your investments and overall market conditions. Review your asset allocation periodically or when your financial circumstances change significantly - e.g.  you experience a drastic change in income or after you have taken on a huge mortgage loan to buy a house. This review helps you determine if the asset mix needs to be re-balanced or specific investments need to be adjusted. This is also when you may decide to sell to limit your loss on a position or take profit to reduce your risk exposure.

During your periodic portfolio tracking (say every quarter), you can also employ dollar-cost averaging. This approach smooths out fluctuations resulting from market volatility as you invest money on a regular basis into a specified portfolio of stocks or funds. For example, if you seek to invest in a stock over a year, you may choose to place your orders over four quarters as it is difficult even for seasoned investors to know when is the best time to enter the market. Executing portfolio diversification requires dedication, understanding how various events affect various asset classes and learning from previous successes as well as failures. In addition, you may incur relatively higher transaction costs as you buy and sell multiple securities. Therefore, it is important to track transaction costs as well for this approach.

As you can see, a sandwich-making approach to investing also brings along a familiar problem: investing may also be more costly and time-consuming to execute by yourself, just like buying all the ingredients for a gourmet sandwich at home.
 

Other Portfolio Diversification Options

At this point, you may wonder – what if I don't want to "make my own sandwich"? Indeed, there are alternatives when pursuing a portfolio diversification strategy such as investing in exchange-traded funds (ETFs) or purchasing Investment-Linked Insurance Policies (ILPs).

To achieve portfolio diversification, you may invest in different ETFs that track different indices.  

Alternatively, if you are looking for both protection and investment, ILPs may be what you’re looking for. When you purchase an ILP, your premiums are used to buy units in investment–linked sub-funds of your choice. ILPs typically offer a variety of funds that may have exposure to different asset classes, and are managed by professional fund managers. This means you can achieve diversification by purchasing the different funds available, without the hassle of managing your own diversified portfolio. For example, if you feel that the technology sector will perform well, you can invest in more thematic funds like technology funds or if you’re looking to lower risk and volatility, you can buy fixed income funds.

ILPs also have a life insurance component which protects you against unforeseeable events such as death or total and permanent disability, alongside additional benefits.For example, Income's Vivalink has a No Lapse Guarantee benefit, which guarantees your insurance coverage in the first 10 years of your policy, regardless of the policy cash value. Furthermore, you will not be charged or limited to a number of fund switches per year (which is brilliant as market conditions change and your risk exposure should be adjusted accordingly). 

Now that you know how diversifying your own portfolio can be as difficult as making a delicious gourmet sandwich on your own, you are better informed to make a choice that best suits your level of investment knowledge and amount of time available to dedicate to track your investments. Happy investing and good luck!

    

Important Notes:
This article is meant purely for informational purposes and should not be relied upon as financial advice. The precise terms, conditions and exclusions of any Income products mentioned are specified in their respective policy contracts. For customised advice to suit your specific needs, consult an Income insurance advisor.

This advertisement has not been reviewed by the Monetary Authority of Singapore. 

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