Why Should You Diversify Your Investments?

“Do not put all your eggs in one basket,” is probably one of the first idioms we all learnt as we studied the English language. Elementary as it is, this is the principle that truly guides an exceptional investor. The more complex term for the phrase is avoiding “Concentration Risk.” As you can guess, this is the danger of putting too much money into one asset such as one job, one investment or even one crop if you are farming.  If the asset performs well, life remains stable. But if it fails, losses become very large and disrupt livelihoods. It can take away almost everything at once, because there are no supporting investments to reduce losses. Concentration risk affects individuals, small businesses and even entire countries, so understanding and mitigating it can protect you from financial disaster.

Concentration risk or the lack of diversification can be easily identified in our everyday lives. A farmer who plants maize on his entire piece of land may do well under the right conditions. But if there is a lack of rainfall or a disease attacks the crop, the farmer’s income is lost at once, because there is nothing else to depend on. A taxi owner using his savings to buy a second taxi instead of spreading the money elsewhere, risks losing all their income if the business fails or a different transport option is availed leading to customers shunning the taxi. The same applies to savings. Someone who puts all their money into one investment option risks losing everything if that single option fails. In each case, the problem lies in carrying too much risk in one asset.

Why should you diversify your investments?

What makes concentration risk dangerous is the unpredictability of when things can go wrong. The nature of concentration risk means that it occurs suddenly and without warning, giving people no time to adjust. Instead, it tends to arrive as a single shock: a poor harvest, a failed business or a market crash. When that shock hits, there is no backup to reduce the damage. This is also true at a national level. Kenya’s economy has been heavily dependent on exports like tea and coffee, so when global prices for these crops fell, the effects were widely felt, from farmers to government revenue. This proves that whether at an individual level or a national level, relying too much on one source leaves little room for recovery if things do not work out.

Simple ways to diversify

We can reduce this risk by diversifying, meaning spreading our risk through multiple investments. Diversification is simple and does not require large amounts of money or financial expertise. The basic idea is to spread things out. A farmer can grow more than one plant instead of relying on a single acre of maize. A Taxi owner can invest his extra savings across different things, such as a small business or a savings account. Someone saving money can place their savings across a number of safer options instead of putting everything in one place. This way, if one part fails, the other options provide a back-up, reducing the overall damage.

The Mansa^X Special Fund by Standard Investment Bank is a highly diversified fund that ensures your money is invested across over 200 asset classes both locally and internationally. The Fund maintains exposure across asset classes and geographies, ensuring resilience across a wide range of outcomes. This includes allocations to hard assets such as precious metals, alongside growth-oriented exposures to structural themes.

Benefits of diversification

Diversification is an important skill that most people already understand in areas of their life: in the words of Peter Bernstein, “diversification is not only as a survival strategy but as an aggressive strategy, because the next windfall might come from a surprising place”.  While spreading risk does not guarantee success, it improves the chances of surviving setbacks. For individuals, businesses and even countries, this simple habit can mean the difference between a temporary struggle and a total financial collapse.

Read Also: Asset Diversification for Retirement Benefits Schemes

This piece first appeared on the Standard Investment Bank (SIB).