Importance of diversifying the investment
Diversifying this $ 100,000 investment will involve allocating funds to a number of financial instruments. The objective of this diversification is to maximize returns from a number of channels, each of which would react differently to a similar event. Diversification of the $ 100,000 investment would enable me to reach my long term financial goals of financial stability.
The major importance of diversifying this investment is that I would reduce the unsystematic risk (Kennon, 2010). The business and financial risks on my investment can be diversified. If there are events such as business failure in my company, I would not lose the entire amount in the circumstances. Without diversification, my entire investment would be washed away by the business failure. If the investment is in the financial sector, I will diversify some amount in the manufacturing sector. Negative trends in the financial sector would be countered by positive trends in the manufacturing sector (Kennon, 2010).
Diversification will have the importance of providing me a chance of accumulating investments that are uncorrelated (Investopedia.com, 2010). They will accommodate my risk appetite, as opposed to a single investment currently. To diversify this investment, I would have to choose financial instruments whose values move in opposite directions with market forces. Negative movements, in such a case, would be offset by positive movements by other financial instruments such as stocks. In addition, a diversified investment would provide me a chance to choose those financial instruments which match with my risk level. If I feel that stocks, for instance, have a high risk, I would opt for bonds in order to reduce the risk (Damordan, 2012).
The other importance of diversifying this investment is capital preservation. This investment strategy will allow me to preserve my capital so that I do not lose to market fluctuations (Kennon, 2010). Allocating the $ 100,000 to different investments will reduce my exposure substantially. In this case, I will retain the value over a number of years. This is as opposed to investing the funds in a single company where the value would fluctuate. Value preservation will be achieved by the fact that an increase in value of one investment will be offset by a decrease in the value of another investment (Investopedia.com, 2010).
The final importance of diversification for my investment can be achieved geographically in order to boost my returns and reduce my risk significantly (Monerchimp.com, 2013). In this case, I would invest in a number of stocks in one neighboring country. Since economic downturns in my home country will not be experienced in other countries, geographical diversification is critical for this benefit. I, therefore, would obtain attractive returns through this strategy. In addition, I would find other investments in the foreign country, through which I can commit my funds in the future (Monerchimp.com, 2013).
Ways of diversifying the investment
There are a number of ways of diversifying this portfolio. The first way is the use of mutual funds. I would allocate a portion of the funds; say $ 20,000 to an actively managed mutual fund. This would give me the benefits of hundreds of stocks. The management expertise of the managers would be another benefit for this diversification (Investopedia.com, 2010). This implies that returns on the funds would be high. Another benefit of mutual funds is provision of a channel to invest across asset classes. Some of my funds would be allocated to fixed income, which would be secure for my investment (Damordan, 2012). A single mutual fund would give me the chance to invest in corporate and government bonds, an investment that could not have been successful otherwise.
The second way through which I can diversify my portfolio is through exchange traded funds (ETFs). Through this tool, I would have my funds track major indices in the stock market such as the S&P 500. My investment would imitate a global index, hence increasing my returns (Kennon, 2010). This would be achieved at relatively low costs, in comparison to tracking the individual stocks. My funds would sweep through a number of industries and market segments. In this case, I would stand to reap from the proceeds in these industries.
The other way through which I can diversify my investment is by acquisition of property. Since it calls for specialized knowledge, I would ask for investment advice from consultants. I may develop real estate with around $ 30,000 of my funds. The benefit of this investment is its provision of stable income over a long period (Monerchimp.com, 2013). Construction of a rental house may be an attractive option for me since it would be simple to manage, and my monthly income would be assured.
Finally, I can diversify my investment through the use of fixed income instruments such as government bonds. Investing say $ 10,000 of the total amount in these bonds will reduce my risk significantly and increase my earnings. This bond would give me a chance to recover my capital if I require it for other investments (Damordan, 2012). This channel of diversification would be critical in managing my portfolio since I would have knowledge on the expected returns.
References
Damordan, A. (2012). A Measure of Risk Tolerance. Investment Management, 22-23.
Investopedia.com. (2010, July 19). Diversification. Retrieved from http://www.investopedia.com/terms/d/diversification.asp : http://www.investopedia.com
Kennon, J. (2010). Asset Allocation Resources. Investing for Beginners, 7.
Monerchimp.com. (2013, February 12). The efficient frontier and portfolio diversification. Retrieved from http://www.moneychimp.com/articles/risk/efficient_frontier.htm: http://www.moneychimp.com
