Don’t Put All Your Eggs in One Basket
Updated: Jun 17, 2022
In the previous post - Getting Along with Risk, we explained :
Risk in investment essentially means how returns (prices) are dispersed,
Risk-return relationship: Higher (lower) return is associated with higher (lower) risk, and
Importance to balance your risk tolerance and expected outcome.
Now, it would be nice for you to learn some basic techniques for managing risk. We now know from the risk-return relationship that we need to accept higher risk to enjoy higher returns. But what if there is a way to reduce risk without compromising your investment return?
Let’s start from Imagining there are four stocks (companies) selling the following products:
You will get high investment return if those companies perform well. What do you think is the best way(s) to manage your investment?
Note: ↓=low, →=normal, and ↑=high and
One of the strategies is to combine 1: Ice-cream and 3: Winter coats. As you can imagine, people crave ice cream on hot summer days, while not so many people eat ice cream during the cold season. On the other hand, many people want to buy winter clothing during autumn and winter, but no one needs it in summer. So, by combining the ice cream and the winter clothing business, you will likely be able to generate higher investment return constantly while offsetting the downside.
You can also add the sweets business that will generate constant revenue regardless of season to raise the bottom line revenue. However, what if you combine ice cream and beach accessories businesses? You will enjoy high revenue during summer, but your investment will be exposed to seasonal fluctuation of return, especially during winter.
The above example is to demonstrate that you can enjoy (higher) return while limiting the downside by combining investment opportunities that move differently from each other. This called “diversification”.
If you decide to invest all your money in only one company, you will be exposed to all the risks that the company has (low sales, bankruptcy, etc.). But if you invest in many companies (or more generally, several assets), their prices move differently from each other, offsetting losses to each other, and lead to consistent returns with limited downside.
This is precisely what we help you do at Krona - Minimizing your risk and maximizing your reward through a personalized portfolio tailored to your investment style.
Krona, at the core of its operation, have diversification which helps to minimize the losses of its user, if any !