Diversification doesn’t just mean distribution
– what is crucial is that the different forms of investment are as independent from one another as possible, and will not all loose value to the same extent e.g., in the event of an economic crisis.
An example: If you invest in different equity funds and shares, the risk will indeed be distributed across multiple companies. However, should a crisis occur, most industries and companies will generally be affected in one way or another. Your portfolio will collapse, in spite of investments being spread out. A good example is the 2008 financial crisis, whereby the collapse of the US property market ultimately also drove the stock markets into an abyss, many banks were on the brink of bankruptcy, and only massive state support running into billions avoided an even more severe outcome. It demonstrated how fragile a globally linked economic system can be, and how an individual trigger can bring about a chain reaction.
This is where genuine diversification comes into play. In the crisis year of 2008, for example, diamond prices were in slight decline, however, this movement was barely worth talking about in comparison to the turbulence seen in shares and property. Why was this? This was because the market for a purely physical product such as diamonds, which is not subject to speculation in the same way as gold, has few points of contact with the stock or property markets. This independence paid off.
So, the following rule of thumb applies: genuine diversification of your portfolio doesn’t just mean diversification within one form of investment, but rather distribution across different forms of investment, whereby these investments are not equally dependent on the same external factors in terms of their development.