Do you really understand the process of diversification for your investments or business? Is it just as simple as buying as many different companies to reduce risk?

Or, should you invest in as many businesses as possible to generate more income streams?

These are all valid questions when it comes to diversifying investments. Hence, this article explores the realities of the diversification process.

Smaller initial capital

Previously, you may have heard of the “rule” of investing in at least 20 or more stocks in the market to better diversify your investments.

As you would need to buy one lot of shares (100 shares) for a company, this means that you would need an initial RM300. This would equate to RM6,000 in total should you opt to invest in 20 stocks.

Today however, you have access to many financial products and platforms that diversify your investments without the need for high capital or worry.

Chief among these is exchange-traded funds (ETFs). These are investment funds that are freely traded which give you exposure to almost all stocks and companies. You can freely buy an ETF on your stockbroking platform, just like how you buy an ordinary stock.

Robo-advisors, on the other hand, help you invest your money according to your preferences and financial goals, and they do so by investing in many different assets in the market. Some robo-advisors have a minimum deposit but they usually don’t exceed RM100.

Diversify according to risk level and preferences

Diversification is also about determining which type of diversification suits your financial goals at different stages of your life.

If you are in your 20s and early 30s, you have a longer investing time horizon, thus your diversification strategy would be to invest in higher-risk investments such as equities, commodities and cryptocurrencies.

For older investors, risk-taking diminishes and diversification strategy should be based on lowering your risk and generating steady returns. The preference here will be to shift into safer investments while retaining a smaller proportion of risky investments.

Build alternatives

The pros of DIY diversification ensures that you have full control over the asset types you wish to acquire based on the current juncture of your financial journey. It also challenges you to do your own research and take responsibility for your investing decisions.

That being said, remember that you need alternatives or a safe investment base (fixed deposits, government bonds) to establish a steady minimum return for your portfolio. This will effectively cap your losses should your riskier investments don’t pan out.

You can also combine a few alternative investments like cryptocurrencies and non-fungible tokens which have higher risks.

Diversifying is not always efficient

When it comes to investment, higher risks doesn’t necessarily mean higher returns and vice versa. Diversification gives you exposure to multiple asset classes and sectors, but the selection matters.

If you diversify your portfolio with companies that are underperforming, you will take on unnecessary risks for little to no returns. That is making bad investment decisions.

If you are electing robo-advisors or fund managers, look for one that has solid financial performances. Diversification is not the end-all be-all investment objective. You still need to do your research in selecting the right kind of assets and financial products.

Supplement your main business

Yes, large companies extensively diversify because they have high amounts of capital to take such risks. However, diversification for an entrepreneur involves creating more income streams that reduce the risk of having just one.

Perhaps what is more important is to actually generate income streams through your existing knowledge of your core business. This way, you can even improve your existing businesses through the synergies from new investments and also ensure that you have a firm grasp on what to do.

Take risks

As an entrepreneur, you diversify by investing and building more income streams for your company.

This means that you will probably have to risk investing in businesses that you might not fully understand or build businesses that might fail. This is very different from diversifying as an investor, where you can just exit an investment if it is not going well.

As an entrepreneur, you are probably stuck investing a lot of your money into businesses and waiting for three to five years for them to generate income.

So, be prepared to take higher risks from the onset.

This article first appeared in MyPF. Follow MyPF to simplify and grow your personal finances on Facebook and Instagram.