Skip to main content

The Need for Portfolio Diversification



Dear Speculators,

Many individual investors fail to diversify their portfolios and suffer heavy losses during market volatile periods. This leaves them frustrated as their dreams of making mega profits in the stock market has been replaced by the reality of mega losses. These losses can be avoided by diversifying your portfolio. Portfolio diversification is the act of investing funds into several asset classes and selective securities in order to hedge against risk and make decent returns.

Individuals can diversify by buying government issued securities, buying corporate bonds, purchasing equities and holding foreign currencies all in one portfolio. This allows such individual to reap gains in some of the securities and minimize losses. It is virtually impossible for any individual to consistently outperform the market on an annual basis. The key element of success is to maximize profits during an up year and as much as possible minimize losses during a down year.

Professional investors are able to make huge returns during good or bad economic periods by going long and short on securities simultaneously to meet their institutional goals. This sort of performance is only attainable through efficient portfolio diversification. We will now introduce you to a few easy steps we take in order to diversify our assets and make good return on investments. First, we use the EIC top-bottom approach to analyse and predict the economy, industry and company direction. This helps to narrow our stock picks. We go long on companies we expect to outperform and go short on companies we expect to under-perform. 

We advice beginners to stick to buying long, that is simple security purchase. Secondly, we plot a graph showing the relationship between the expected return of our selected stocks and their risks. We then select only stocks that possess the highest returns given a particular level of risk. This further reduces our portfolio size. Thirdly, we analyse the correlation of our selected securities and accept only stocks with high returns that are negatively correlated. Lastly, ensure that the intrinsic value of the individual securities is greater than their market prices. At this point our portfolio is ready for asset allocation and we will have eliminated any stock with positive relationship to another in the portfolio or random stocks with unpredictable price movements. This leaves with an effective portfolio. The final portfolio should be represented by securities in different asset classes where when combined should provide excellent returns, lower risk and may outperform the market portfolio.

This tips by no means promise any investor the ability to consistently outperform the market but serve as useful tips in security selection and portfolio diversification. Mutual funds and index funds are good ways to diversify your portfolio for small fund investors but these funds are not always effective. In the long term, index funds are very excellent options for strategic investors.

Signed:
Emeka Ucheaga,
Managing Partner,
Emeka Ucheaga Advisory

Comments

Post a Comment

Popular posts from this blog

The Wrong Forecaster

Dear Speculators, The gloominess of the Nigerian economic outlook has significantly knocked down the prices of some financial assets but the real value of some of these assets have been mildly affected. While recounting the economic misfortune that has befallen the country in the last two years is inevitable, dwelling on the past is a perfect time wasting activity. Luckily, investment is forward looking and not regressive thinking. The past is a great indication of the future but not a mirror for prediction. The randomness of the world ensures that yesterday looks at least slightly different from tomorrow. And if we have learnt anything from the history books, it is that good things do not last forever and bad times always have an end. Life is by definition cyclical. The key questions to ask before buying or selling any financial asset is; will the current economic situation last forever? Will the inflation rate remain in double digits over the next 5 years? Will the Nai...
Post a Comment
Read more

Everything is Going Down in Nigeria Except Inflation

Dear Speculators, The wait is over, we anticipated bad news and we got it. Our fears have become reality, the economy has continued to back slide and Nigeria has officially tipped into a recession. Not that this surprises anyone though. Falling oil prices, dollar scarcity, exploding oil pipelines, massive labour retrenchment and import restrictions have all contributed their fair share to weaken growth in Nigeria's economy. However, the stock market arguably has had it worse than the general economy this year as the market is currently down about 3.8 percent against an economy contraction of 2.06 percent in the second quarter. A closer analysis of the stock market brings to light some intriguing statistics. The largest 49 companies in the stock market account for 97% of the total stock market capitalization. 41 companies of the 49 sell at an average of 22x earnings. Only 49 companies out of a total of 171 companies trading on the Nigerian Stock Exchange are valued above ...
Post a Comment
Read more

It's a Dip not a Bear

Despite strong economic fundamentals and fairly optimistic market sentiments that have driven stock market prices in the past year and even stronger since the start of 2018, stock markets all around the world are witnessing an unexplained coordinated price descent in the past one week. Asides the biggest bitcoin price crash in years, now 66% lower than its record high price of $19,500 in December, nothing out of the ordinary has occurred. Yes, stock prices are at the highest it's been in since pre-crisis era in U.S and the market is due for a price correction but then how do we explain market dips in relatively cheap emerging markets? Something is amiss! As Central Bankers around the world have begun to discuss monetary tightening in a coordinated fashion as the quest for 2% inflation seems more achievable this year due to strong global economic and rising commodity prices, bond prices have dropped precipitously and the U.S 10 year Treasury bills risen above 2.5% a...
Post a Comment
Read more