The Importance Of Diversifying Your Investments

“Don’t put all your eggs in one basket” is a popular saying, used all over the world, which perfectly summarizes the importance of the concept of investment diversification when creating a portfolio.

Investment diversification is a necessary action for those who want to reduce portfolio risk and protect their assets, in addition to being one of the first factors to be observed during the interview and profile understanding phase.

Despite the theme being widely studied by several analysts, one of the most relevant contributions regarding the ‘Diversification Description’ was made by the American economist Harry Max Markowitz through the 'Modern Theory of Portfolios', for which he received the Nobel Prize in Economic Sciences in 1990.

The theory is based on statistical bases and calculations, and, through it, the economist was able to show that the act of diversifying a portfolio becomes essential, especially for reducing risks and maximizing gains in the long term during this construction of efficient frontiers in optimized portfolios - being able to estimate the ideal size of a portfolio based on a statistical model.

That said, the correlation of companies would need to be considered when composing the portfolio. When making any type of investment, it is important to look at the companies' sector of activity as soon as possible, structuring a portfolio with allocations in companies from various sectors, such as civil construction, logistics, energy, education, financial services, metallurgy, among others. In addition, seeking a market composition strategy, investing in complementary asset classes, such as: cash, fixed income, real estate, shares, foreign exchange and currencies, mutual funds, commodities, inflation and protection, cryptocurrencies, etc.

There is no ready-made rule or formula that indicates which is the best method to diversify; everything will depend on your investor profile, investment horizon and objectives. There are products that tend to perform more consistently, providing less volatility in the short term, as well as others with a tendency towards greater gains in the coming periods.

This is precisely the main advantage of the Markowitz Theory applied in everyday life: the feasibility of building a portfolio where the performance of all assets is more important than individual returns. This leads us to the widespread concept of the Dominance Principle, which states that: between two assets with the same return potential, but with different risks for each one, the investor would choose the one with less risk.

Diversification requires the elaboration of a strategic approach based on knowledge of the financial market so that the investor's portfolio corresponds to the objectives of each client, for this reason it is extremely important to talk to an investment advisor to gather the best product options available and frequent monitoring of the progress of the markets.

A practical case of a diversified portfolio for a moderate profile would be: 60% in low risk fixed income, 15% in corporate bonds, 10% in mutual funds, 5% in equities, 5% in real estate and 5% in offshore investments. In this way, the client can compensate any losses with more significant gains in other classes, and vice versa.

For this example, it is easier to understand that, as the economy is subject to numerous agents that walk in different directions, diversifying is a way to protect your income in different economic cycles.

Harion Camargo, CFP®

Technician in Logistics Management. Bachelor’s in international Trade and postgraduate in Financial Engineering. He has an intensive Business Supplementary course from Kaplan and studied Applied Economics for an MBA. Master's student in Business Administration with a line of research in behavioral finance.

He has been in the financial market, in Brazil, for nine years. He is a CFP® professional.

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