During 2022, Networth of Mike Zuckerberg, owner of Facebook and Whatsapp, plummed from $122 billion to $45 billion whereas Berkshire chief Warrant Buffet’s networth gone up from $104 billion to $109 billion.
You know why?
Because Zuckerberg’s portfolio
mainly consists of shares of Meta (Facebook) and due to fall in tech stocks his
net worth fell significantly whereas Buffet’s portfolio consists of many
diversified companies so some of the company’s prices fall but some of them
went up as a result his net worth actually went up during this time.
Zuckerberg is not the only person
who lost his net worth last year other billionaires like Elon Musk (owner of Twitter
and Tesla), Bill Gates (Micro soft) and Jeff Bezos (amazon) also lost
significantly during this time as they have their portfolios concentrated to
their own few companies.
So what is the lesson from
this?
Stock market is always Volatile.
It will never move as per our wish or we can’t predict its movement also, but
we can protect ourselves (to some extent) using Diversification.
Diversification is a risk
management strategy that dilutes the risk by distributing a wide variety of
investments within a portfolio.
Diversification’s objective is to
smooth out unsystematic risk events in a portfolio, so the positive performance
of some investments neutralizes the negative performance of others.
Types of Diversification:
There are lot of strategies to
implement diversification. Some of the basic strategies which can be used by
investors to improve the level of diversification within the portfolio are
given below:
1. Asset Classes:
In this strategy, capital is
distributed among different type asset classes like Stocks, Bonds, Commodities,
Real Estate, ETFs and Cash or cash-related instruments.
2. Industry/Sector
Different industries or sectors
work in different way, they have their own business cycles. When investors
diversify across different industries, they become more protected against
sector-specific risk.
3. Growth / Value
Generally we can divide Stocks into
two types Growth and Value.
Growth stocks perform better in
good economic conditions and can be riskier if expected growth of company and economy may not materialize.
Value stocks tend to be more
established, stable companies usually carry less risk.
By distributing capital in both, we
can capitalize on the future potential of some companies while also recognizing
the existing benefits of others.
4. Large / Small
Large companies are more stable
but will have normal growth based on economies while small companies carry high
risk but can multiply there business in short span of time. By allocating
capital to both, we can insinuate potential growth through lower-cap stocks and
safety through large-cap stocks.
We should also keep in mind
that:
Diversification doesn’t mean we
buy anything and hold onto it until the end of the world. The main idea of
diversification is to keep distributing our money among different asset classes
to reduce risk and optimize returns. We should also reassess the portfolio
frequently and redistribute from higher risk to lower risk as we don’t know
which asset class will perform and when it will perform in a particular period.
Mutual funds can be a good option for diversification purposes.
Like anything Diversifications
has some drawbacks along with its benefits, these are:
As we would be putting our
investments in various asset classes so it will involve cost also. It is a time-consuming
and regular monitoring job. In short term, it may not give very attractive
returns and can be disappointing and for new investors, it can be a bit
exhaustive to do all this initially. However, looking it’s benefits it will be
better to plan it properly.
Finally, remember that:
In the short term, the market can
be irrational but in the long term, it’s always rational. We will get good results
if we respect and stick to your Risk Management Strategy.
