Diversification – Beyond the Basics in Canada

Diversification – Beyond the Basics in Canada

Diversification—it's a term frequently bandied about in financial circles, often touted as the tried-and-true method to protect investments. For many Canadian investors, diversification might mean spreading their investments across different sectors of the economy or choosing a mix of Canadian equities, bonds, and maybe a sprinkle of international stocks. However, true diversification—especially in today's dynamic global economy—requires a deeper understanding and a more strategic approach.

Why Diversify?

Firstly, let's revisit why diversification is essential. At its core, diversification is about risk management. By spreading investments across a range of assets, you minimize the impact of any single asset's poor performance on your overall portfolio. Essentially, not putting all your eggs in one basket.

Diversification—the practice of spreading investments across a multitude of assets to mitigate risk—is a cornerstone of modern investment philosophy. Simply owning stocks in a handful of companies exposes an investor to potentially significant losses. This risk is reduced as investments are made across various economic sectors, asset classes, and locations. True diversification, particularly vital for Canadians, entails the addition of assets with low correlations, i.e., assets unlikely to move in tandem.

Understanding Stock Diversification

Canadian investors may fall into the trap of believing that purchasing an index mutual fund, which represents a basket of shares from different companies, is adequate for stock diversification. A prominent example is the S&P/TSX Index, representing around 250 out of the 1,500-plus companies listed on the Toronto Stock Exchange.

However, here lies a caveat: the S&P/TSX Index is disproportionately focused on three sectors: financial services, energy, and materials. These sectors are interlinked. For instance, a global economic slowdown tends to hit energy and commodities, which in turn affects financial firms relying on resource companies. Achieving effective diversification, thus, requires a gaze beyond Canada’s borders and beyond these dominant sectors.

Diversifying the Canadian Portfolio

Moving away from the “home bias” can lead Canadian investors towards greater stock diversification. Here are some avenues to consider:

- Geography: Diversifying based on geographical considerations includes looking at investments in the U.S., Europe, Emerging markets including China, and other global opportunities.

- Sectors: Diversification across sectors can be achieved through investments in IT, Industrials, Telecommunications, Consumer staples, Health care, and more.

- Fixed Income Investments: Broaden the scope with Government bonds, Corporate bonds, and Municipal bonds.

- Company Size: Investing across large cap, mid cap, and small cap companies ensures exposure to varied company sizes and dynamics.

- Stock Type: Balancing a portfolio with value stocks and growth stocks can offset potential risks.

One of the most efficient diversification methods is through mutual funds. With over 5,000 mutual funds available to Canadians, the opportunities are vast. Furthermore, sustainable investment funds offer an ethical and often lucrative avenue for diversification.

Alternative Investments – The New Frontier

With an increasing emphasis on diversification, financial experts now advocate for an allocation in alternative investments. Some popular options include Real Estate Investment Trusts, leveraging strategies, private equity, and private debt. These investments, once primarily accessible to institutional investors, are now available through specific mutual funds.

Bracing Against Market Volatility

Market volatility is inescapable. However, holding equities in diversified portfolios can speed up portfolio growth, and investments in low-volatility funds can mitigate the rough patches, ensuring stability even amidst market fluctuations.

Enlisting Expertise

While the benefits of a diversified portfolio are clear, the path to achieving true sustainable diversification can be less so. Navigating this path alone can be daunting. This is where expert guidance, like what we provide at DO Wealth, can prove helpful. We consider an individual's risk preferences, personal circumstances, financial aspirations, and craft a mix of equities, bonds, and alternative assets to construct a genuinely diversified portfolio.

To truly protect and grow your investments, diversification is key. Contact us today!