Why is it important to diversify your assets?
Why is it important to diversify your assets?
"Don't put all your eggs in one basket". This is certainly the financial advice you have heard the most! Diversifying your investments is essential to building your wealth properly. Find out why in this article.
Diversifying your wealth: the theory
Let's start with a little bit of theory. Even if wealth diversification is not the main topic of economists, there are theoretical bases on the subject.
The Markowitz theory
Harry Markowitz is an economist who developed a theory in 1952 that portfolio diversification can help reduce risk and improve the profitability of an investment.
To make it simple, Markowitz's modern portfolio theory is based on two main principles:
- The expected return, which is the expected gain or loss.
- Variance, and especially covariance, which consists of investing in assets whose fluctuation in return is not correlated.
You must pay attention to these two principles to build an optimal portfolio.
Spreading your assets in your wealth
Portfolio diversification is one thing! But in concrete terms, how do you allocate your different assets in your wealth? Unfortunately, there is no ready-made answer to this question, but you can orient your allocation according to the following criteria.
- Your risk profile: if your risk aversion is low and the return you expect is high, you can devote a large part of your assets (at least 50%) to riskier investments.
- Your age: the younger you are, the more risk you can afford to take. Why? Because you have a better chance of recovering potential losses. Your financial safety net is less important than if you are retired, for example. Of course, this also depends on your financial means.
- Your need for liquidity: Finally, liquidity is also important in the allocation of your assets. If you only invest in illiquid assets (which cannot be quickly converted into cash), you expose yourself to risks in case of urgent need.
To build your wealth, it is therefore important to diversify the assets you invest in. Think of it as a house of cards: the more cards you have to build your base, the stronger your house is.
The advantages of diversifying your assets
In the current inflationary context, diversifying your assets will allow you to reduce your risks while improving your profitability.
Reduce your risk
The first advantage of diversifying your assets is obviously to reduce your risk of loss. Let's go back to our covariance principle with a very simple example.
Let's say you have invested in two asset classes that are directly dependent on the financial markets. If the financial markets fall, all of your investments will be impacted.
Now, if you have invested in two asset classes that are not correlated (corporate stocks and real estate, for example). If the financial markets fall, only the value of your stock portfolio will fall.
Your risk is limited.
Improve your profitability
Each asset type has unique return characteristics and different economic cycles. By diversifying your portfolio, you can take advantage of the benefits of each of your investments as economic conditions change, thereby maximizing your overall return.
Protecting yourself against inflation
Consumer prices in March 2023 are up 5.6% from March 2022. In a context of strong price increases, diversifying your assets and investing in alternative assets allows you to protect yourself against inflation.
Here are a few alternative investments to minimize your risks and boost your returns.
Alternative assets to diversify your assets
Beyond the various types of traditional investments such as financial investments or real estate, there are assets on which you can invest and hope for an interesting return.
Here are some types of alternative assets to invest in, with some figures:
- Watches: in the 1980s, a Rolex Daytona was worth about €1,500. Today, it can be sold for around €150,000!
- Works of art: a well-chosen work of art worth more than €100,000 could earn about 10% per year. For works between 50 and €100,000, the return would be 5% to 7% per year.
- Wine: the most expensive bottle in the world is a 2000 vintage Petrus sent into space. It is estimated at €830,000!
- Bags: on average, the value of a luxury bag increases by 14.2% every year.
However, investing in alternative assets requires a precise knowledge of their market. Each asset has a history, a quality, a rarity, a brand. It is essential to know the product and the market perfectly to make the best investments.
At Diversified, we choose for you the best properties to invest in to diversify your assets and boost your profitability. Join our waiting list!