You will often hear the word “diversification” when you discuss about investmetns. Diversification is important, in fact it is still considered one of the most effective risk managment tool, minimizing investment losses.

What does Investopedia say about diversification? (a favorite on-line site for invesmtment stuff)

“A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio.

Diversification strives to smooth out unsystematic risk events in a portfolio so that the positive performance of some investments will neutralize the negative performance of others. Therefore, the benefits of diversification will hold only if the securities in the portfolio are not perfectly correlated.”

What does the Bible say about diversification?

“But divide your investments among many places,
for you do not know what risks might lie ahead.”

— Ecclesiastes 11:2. New Living Translation.

Both definitions are essentially the same but I like the one from the Bible better — I understand it better and I am sure it is the truth.

..con’t. (Part 2)

Let’s simplify this. Because of the fears of losing money brought about by the crisis, the preference for safer havens increased the demands for fixed income securities. Price of said investments has an inverse relationship with yield – so as price increases, yields go down. Yields of such ‘safe’ investments have plummeted to a point that they are starting to be very unattractive and are forcing many to look elsewhere. Central Banks all over the world are keeping interests down to keep money circulating in the economy so we can’t see any improvement in the yields of new fixed-income securities as well. All these makes investors go out and look for avenues where they can get better performances.

At a certain point when the markets are too liquid, money needs to be invested, otherwise money will actually lose value because of inflation. Staying out of the equities market is a knee-jerk reaction to cut losses when things become awry. However, it can’t be expected that people will totally forget about the market as they are just waiting for signs of some recovery before they start taking positions. The question in my mind is, are we really seeing recovery? The US equities market has seen a remarkable 30% increase from its lowest point and thereby also having a positive effect in the Philippine market. Is this a sign that the stock market is in full recovery? Only time will tell. It’s not that I am sceptical; I pray every day that we see some recovery and eventually growth. But we need to look at things from a more prudent perspective. Here’s the FACT: the global economy crashed and is in recession. The damage is so severe that it will take time for institutions to heal and recover.

I maybe reading too much into things but here is a thought that occurred to me — can it be that one of the reason why there is action in the stock market is that people are seeing that inflation will shoot up soon?  Equities are a good hedge against inflation, much better than the safer fixed-income securities (well, at least in theory). A high inflation is not a remote possibility; it’s actually a very real one. With the way governments are pumping money into the economy, it puts a lot of pressure on inflation. Are people speculating too much, too soon? I don’t know, maybe. Is it time to start investing in the stock market again? I’m not sure; I wish I knew the answer to that too.

I will stick to my rules before letting go of my money (if I had any): Investment Objective, Time Frame, Risk Tolerance and Acumen. There is also a view that the market is now ‘over-bought’ so there is an expectation of some correction. If you have invested in the market you can do two things, get your profits and leave or just leave your money there and wait for the market to recover – it will definitely recover, we just don’t know when. I am not a technical guy and I’m not a big believer of timing the market so you know what I would do if I have money in the market.

Well, just to remind people that all these are just IMHO (In My Honest Opinion) and HTH (Hope This Helps).