Diversification To Suit The Client’s Objectives

Question 1

Define diversification

Answer 1

1. Diversification is a key principle in investment management that helps manage risk by spreading investments across various asset classes, sectors, and geographical regions.
2. Since no single asset class is entirely risk-free, a well-diversified portfolio can help balance different types of risks while aligning with the client’s financial goals.

Question 2

How does diversification across different asset classes help manage investment risks?

Answer 2

1. Cash:
   A. Low capital risk (cash deposits are generally safe, especially when held in insured bank accounts)
   B. High shortfall and inflation risk.
2. Bonds:
   A. Moderate capital risk, lower volatility than equities.
   B. But, exposed to credit and interest rate risk (when interest rates rise, bond prices fall, and vice versa)
3. Equities (Stocks):
   A. Higher capital risk (stock prices fluctuate due to market conditions, company performance, and economic factors, with potential for significant losses)
   B. But, historically offer better inflation protection over the long term.
4. Property:
   Provides potential long-term capital growth but lacks liquidity and can be impacted by market cycles.
5. Commodities (e.g., gold, oil):
   Useful hedge against inflation but can be highly volatile.