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Diversification in Financial Planning

5 January 2021

The idea that you can get something for nothing is almost inconceivable for an economist.

At least it was, until Nobel Prize-winning Economist Harry Markowitz, the father of Modern Portfolio Theory, demonstrated that a diversified portfolio could achieve improved performance and lessened risk relative to individual asset classes. He called diversification “the only ‘free lunch’ in finance”.

Sometimes we come across the common misconception that owning a variety of stocks means that you are well-diversified. Instead, when we talk about diversification, we are usually talking about holding a variety of asset classes.

Each asset class has varying characteristics and benefits, such as differing risk/reward profiles, costs, and time horizons that can help manage your overall risk. These can come in the form of cash, bonds, funds, shares and property. As your age, goals and risk appetite change, you’ll probably want to change the amount you have in each asset class.

Investing in a variety of stocks is a good way of diversifying within that asset class. Ideally, you should be holding stocks across various industries and sectors. Since different sectors perform at different paces, this provides a counterweight to our portfolio.

We find that many would-be investors are waiting for the perfect time to get in or are waiting to have a large sum of money to invest. The truth of the matter is that you should invest early and often to harness the power of compounding over the long term.

Investing R10 000 annually over five years and investing R2 000 annually over 25 years equates to the same total contribution of R50 000. However, despite having the same contribution, the investment over 25 years has a difference in return of almost R100 000.

One of the first things we learn when playing organised team sports is to play your position. If every player is chasing the ball, then you have left the pitch wide open behind you. Diversification allows us to play the field, cover our bases, and when the ball comes our way – we run with it.

At SFP, our team has been selectively chosen and tasked to create and deliver diversification strategies that are on par with the best on offer, at a global level. This helps our clients, and our planners, enjoy “the only ‘free lunch’ in finance”.

Sanlam Life Insurance is a licensed financial service provider.
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